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Pension bombshell to create fresh ‘death tax’ for beneficiaries

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The Government quietly snuck out a major proposed change to pension tax which would hit some beneficiaries inheriting an untapped retirement pot following the death of a loved one.

Buried within the Government consultation on abolishing the pension lifetime allowance, a statement relating to ‘benefit crystallisation events and charges’, read:

“Individuals will still be able to receive the benefits… but the values will no longer be excluded from marginal rate income tax under ITEPA [Income Tax Earnings and Pensions Act 2003], with effect from 6 April 2024.”

Since 2015, it has been possible to inherit an untouched (uncrystallised) defined contribution pension pot free of both inheritance tax and income tax, where the person died under the age of 75.

This holds for beneficiaries who choose to receive an income from this either via drawdown or by buying an annuity where the income would be tax-free.

However, the Government bombshell suggests that if someone inherits a pension pot in this scenario, they would be subject to income tax at their marginal rate next year.

By contrast, if the same person took the inherited pension as a lump sum and it was within the £1,073,100 lump sum limit, it would remain tax-free.

‘Political firestorm for the Government’

Tom Selby, head of retirement policy at AJ Bell, said: “Creating a tax on death in this way makes little sense and may push more beneficiaries to take a lump sum when an income is more suitable for their needs. Or encouraging the member to take their pension benefits earlier than planned to avoid their loved ones paying income tax. It also risks causing a political firestorm for the Government and undoes much of the simplification benefits associated with ditching the lifetime allowance.”

Steve Webb, former pensions minister and now partner at consultants Lane, Clark and Peacock, said: “For the last eight years, people have known that if a loved one died under the age of 75 they could inherit an untouched pension pot free of all tax. The money could sit in a drawdown account, being invested and growing, and would be a source of tax-free income whenever needed.

“This tax advantage risks being abolished by next April if these new proposals are implemented.  It would be totally unacceptable to make such a big change ‘through the back door’. If Ministers plan to remove this pension tax break they should announce their plans publicly and have them properly debated.”

Experts also commented on the confusion caused by this discreet update.

Selby said: “The rules are still to be finalised in legislation and at this stage it is not yet 100% clear exactly how pension assets will be treated on death. Although the government’s briefing note and subsequent newsletter suggests the introduction of the new ‘death tax’ for those who die before 75, this isn’t specified in the draft legislation tabled. This needs to be clarified urgently so pension savers can make informed decisions based on the planned rules, albeit those rules could yet be re-written if a future Government changes pension legislation again.”

A Government spokesperson said: “We want to keep 15,000 experienced people in work to help grow our economy and clear backlogs, such as seniors in the NHS who had told us that pensions tax was disincentivising them from working, which is why we have abolished the lifetime allowance.

“We look forward to working with stakeholders over the coming weeks to help us craft the legislation which will ensure that our historical pensions tax cut delivers the right results for savers and the economy.”

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