There will be others who may be simply unaware of the government’s plans that could impact their private and workplace pension savings as other policies aimed at balancing the nation’s books and controlling our borders continue to dominate the domestic news coverage.
When the reforms were announced in the Autumn Budget back in October, a technical consultation followed seeking views on the proposals for the reporting and payment of any inheritance tax on the pension component of an estate.
The response to that consultation has now been published and, whilst there are some changes around the administrative responsibilities (personal representatives rather than pension scheme administrators will be responsible), the government has made it clear that it intends to implement its overarching inheritance tax policy, despite strong industry consensus pointing to simpler alternatives. There are to be no U-turns afforded to these pension reforms.
It is somewhat ironic that, on one hand the Government is increasing the tax burden on pensions, but has also revived the Pensions Commission to tackle the barriers that stop pension saving. Their policy of taxing pensions on death is not conducive with encouraging people to save more into their pensions.
The reality of what this all means is that, from April 2027, if the value of a person’s estate, once unused pension funds are included, exceeds the nil-rate band (currently £325,000), then inheritance tax may apply on the excess.
It is important to note that the usual spousal exemption will apply. There is no inheritance tax to pay on estates passed to, and gifts between, UK domiciled spouses and civil partners.
The government estimates that, from the estates with inheritable pension wealth in 2027 to 2028 (and before assuming any behavioural change), around 1 in 4 people will be impacted. That translates to 38,500 estates having to pay more inheritance tax than previously, and 10,500 estates becoming liable for inheritance tax where this would not previously have been the case.
For those affected, simplicity has now been replaced with complexity and a much higher tax bill.
As things stand, it is a relatively simple affair of ensuring expression of wishes are up-to-date and, there is the peace of mind in knowing that no action is necessary for any pension leftover to be passed on without any inheritance tax implications, no matter when death occurred.
These changes will mean that active decisions will be needed to attempt to balance an individual’s own needs as well as leaving beneficiaries in the best position, if they have concerns around the inheritance tax impact.
A further sting in the tail is that the existing income tax treatment on unused pensions on death will continue to apply, whereby the age at death will be a determining factor for the income tax treatment in the hands of the beneficiaries.
Where death occurs before age 75, any lump sum or income withdrawal will be tax free. Where death occurs after age 75, any lump sum or income withdrawal will be taxed at the recipient’s marginal rate.
This presents the dim prospect of some unused pensions on death suffering both inheritance tax and income tax (where the nil-rate band is exceeded and death occurs after age 75).
No doubt, for some, the changes will make them consider accelerating the drawings of their pension benefits to enable gifting.
But here time is of the essence as generally a seven-year rule applies to gifts, as no inheritance tax is due where the transferor lives for seven years after giving the gift. However, death within seven years of giving a gift is subject to inheritance tax (gifts given in the three years before death are taxed at the 40% standard rate and gifts given three to seven years before death are taxed on a sliding scale, reducing the rate by 8% per year).
Additionally, regular payments made from income (including pensions) can be considered and benefit from being exempt from inheritance tax provided they are part of an individual’s normal expenditure and they are left with enough to maintain their normal standard of living.
Spare a thought to what could be described as an extremely unfair situation should death occur before age 55, which is normal minimum pension age, and the earliest point pension benefits can normally be accessed. In such a situation, an individual would not get the benefit of their pension in their lifetime (so not have the opportunity for gifting) but potentially suffer inheritance tax. That does appear particularly harsh and does not suggest joined up pension policy thinking.
Often the cost associated with professional advice is the focus, rather than the value the advice offers. This is perhaps one area where the value of advice and planning can be tangibly measured.
But whether getting professional help or going it alone, for some it is no longer the case of “wait and see”.
Lee Halpin is head of technical services @sipp