HMRC is proposing to change the rules around the income tax paid on withdrawals from a pension pot by beneficiaries, which could mean a reduction in income for those in receipt of their deceased partner/relative’s (in most cases) pension.
Current income tax liabilities for inherited pensions
Under current legislation:
- If a pension holder dies before the age of 75, their successor inherits the pension tax-free and can withdraw from the pension without paying income tax.
- If a pension holder dies after they turn 75, their successor inherits the pension tax-free, but they will pay income tax at their marginal rate on any withdrawals they make.
he introduction of the pension freedom legislation in 2015 significantly changed the tax landscape for those inheriting pensions. It applies to Personal Pension Plans (PPP) and Self Invested Pension Plans (SIPP), both collectively known as defined contribution or money purchase pensions (it does not apply to defined benefit/final salary pensions).
These changes made pensions more attractive.
In addition to the tax relief on contributions, pensions generally sit outside of an individual’s estate and are not subject to Inheritance Tax, and added to that, the fact that a successor could have tax-free income (if the original investor dies before age 75) makes a pension contract extremely appealing as a form of wealth protection.
Proposed changes to income tax for pension beneficiaries
HMRC’s proposal will change the tax treatment of pension pots for some who inherit them.
If approved, it would mean beneficiaries inheriting a pension from someone who dies before the age of 75 may have to pay income tax on withdrawals they make.
The proposed revision applies to both pensions that have already been accessed and those that are untouched.
Former Pensions Minister Sir Steve Webb has said: “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.”
How could this impact those who inherit a loved one’s pension?
For the past eight years, following the Pension Freedoms introduction, it has been well-publicised that if a loved one died under the age of 75, the beneficiary could inherit an untouched pension pot free of all tax.
The money could sit in a drawdown account, continuing to be invested and subsequently growing, with the comfort that this would be a source of tax-free income whenever needed.
Therefore, this proposed change might be a cause for concern; however, we must not forget the main motivators for pension accumulation, which are:
- To provide for your own retirement, and this proposed change will not have any material impact on such planning.
- To pass funds on tax efficiently to your successor (spouse, partner, children etc.). There will be an impact for those who look to draw an income on receipt because they will pay income tax. However, the current proposals do not appear to impact the IHT efficiency of pensions.
Pension planning for you and your loved ones
There are lots of ways you can look to provide financial support for your family through the legacy you hope to leave; you may consider the merits of each holding your own pension contract and even setting up a pension for your children where suitable and affordable, or having a range of savings vehicles and wrappers such as ISAs and bonds.
However, what is key to remember, is that each set of circumstances is unique and it is always best assessed by having regular review meetings with your trusted financial adviser.
To help guide you through all stages of your financial planning please contact our Financial Planning team for a review.
Call 01768222030 or email justin.rourke@armstrongwatson.co.uk for more information.
