The Institute for Fiscal Studies (IFS) has detailed proposals, aiming to make the tax rules of pensions at death “fairer and more economically efficient”.
The IFS details that many people are using pensions as a vehicle to pass more money on to their families. Because any funds that remain in pensions after a person’s death are not subject to inheritance tax, the IFS suggests that people fund their retirement through non-pension assets so that a maximum amount can be passed on via the pension pot.
The IFS’s suggestions aim to make the system “fairer” and raise more money for public services.
- Basic-rate income tax could be levied on all funds that remain in pensions at death. Or, current income tax rules could extend to those inheriting pension pots from someone who dies before age 75.
- Pension pots should be included in the value of estates at death for the purposes of inheritance tax.
- Subjecting pensions to inheritance tax would raise revenue and remove the perverse incentive to avoid using a pension to fund retirement.
- The government could use the revenue to cut the inheritance tax rate and/or increase the threshold.
- Reforms should be announced as swiftly as is practical
Alice Guy, personal finance editor at interactive investor, gave her view on the impact the proposed changes could have. She explained: “Today’s report is strong stuff and the content will be up for debate, to say the least. As part of this conversation, it’s crucial that trust in pensions is preserved. Investors should also continue to see pension saving as a tax-efficient and attractive in the long term.”
Changes could damage ‘trust and confidence’ in the pension system
Guy explained that introducing the IFS proposals could do more harm than good for individuals in the UK. She said: “Inheritance tax and pensions are highly emotive. Any changes could have a significant impact on trust and confidence in the pension system.
“Changing the rules around inheritance tax and pensions could significantly impact the attractiveness of pension saving and income drawdown. Whereas defined benefit pensions with survivor benefits would not be impacted by a rule change.
“Pensioners with a defined contribution pension need to keep their pension pot invested, to enable them to draw an income right through retirement. Those who have investments left when they die are not necessarily wealthy. They are simply keeping investments to enable them to draw an income for as long as they live.
“Any changes would disproportionately impact unmarried couples, who are not entitled to spousal IHT exemptions and may have significant tax to pay on an inherited pension.
“More than anything, retirement outcomes are currently being compromised by a lack of understanding about pensions. It’s important that we focus on making sure the next generation is retirement-ready.
“The interactive investor ‘Great British Retirement‘ survey showed that nearly one in four (24 per cent) of the general population say they know nothing about pensions. Furthermore, many are overestimating their retirement income by an average of around 30 per cent.”