AJ Bell is urging the Government to “go back to the drawing board” and rethink proposals to bring pensions into the scope of inheritance tax, with its latest research showing that advisers strongly oppose the policy change.
Almost all advisers (94%) believe that inheritance tax is not the best way to tax pensions on death, the research revealed. Instead, advisers are in favour of putting in place simpler solutions such as charging income tax on all inherited pensions (42%) and levying a flat tax charge on unspent pensions on death (44%).
Under proposed changes unveiled in the Chancellor’s Autumn Budget, unused pension funds will become subject to IHT on death from April 2027. The proposals mean any unspent pension assets on death will be treated as part of the individual’s estate.
However, AJ Bell said advisers agree that the current proposals are unworkable and could wreak havoc, with the potential for punitive levels of taxation.
Current proposals mean that once passed to the beneficiary, income withdrawn from the pension may be subject to income tax at their own marginal rate, depending on the age of the member when they died.
The double taxation proposed means that pension assets will be subject to a 64% effective tax rate on death where the pension pot exceeds the IHT nil rate band allocated to the pension and the beneficiary is a higher rate taxpayer, rising to as much as 90% or more where the residence nil rate band is tapered away entirely.
Rachel Vahey, head of public policy at AJ Bell, said: “On top of the administrative nightmare for families dealing with bereavement, the current proposals will result in additional complexity and costs for executors as they struggle to untangle the implications of pensions, set up under trust, being caught by the IHT net.
“To add insult to injury, beneficiaries could also feel the double whammy of both IHT and income tax on their inherited pensions, meaning higher-rate taxpayers facing a marginal rate of tax of at least 64%.”
In addition, the proposals are also likely to cause significant delays distributing money to families on death and paying any IHT due, leading to the risk of substantial late interest payments being added on.
Vahey explained: “Calculation and payment of IHT is already a burdensome and complicated process. But trying to cram pensions into the six-month probate window will cause further delays, costs, and distress for bereaved families.
“Liquidity also presents a major challenge under the current proposals. Pension funds holding illiquid assets, something the Government and the FCA are specifically trying to encourage through the creation of long-term asset funds and wider policy initiatives, will often struggle to sell these within a year, let alone six months.”
AJ Bell’s research found that more than half of advisers are seeing new clients come to them for advice on how to prepare for any changes, with over 8 in 10 reporting an increase in queries around estate planning. Almost two-thirds are also recommending that clients access their pensions earlier and just under half have suggested clients take advantage of gifting rules, with a third recommending clients update their expression of wishes forms.
There are also widespread concerns over how these proposals will change pension saver behaviour.
Vahey said: “Some pension savers will choose to withdraw their funds at a faster rate, leaving less in the pension. They may choose to gift these funds to others to avoid future IHT or invest in more risky investments or products, which may not be suitable for their personal circumstances, to mitigate the IHT due.
“By encouraging a faster withdrawal of pension funds, there is a real danger that more people will leave themselves with insufficient income to last their lifetime, risking falling onto the state for support in their later years. It could also have implications for funding long-term care, as people who deplete their pension earlier will have fewer resources to pay for that care.
“Needless to say, these concerns around changes to pension saver behaviour and the associated impacts risk exacerbating the challenges that already exist in this policy area.”
AJ Bell is calling on the Chancellor to explore alternative measures it believes would be simpler and fairer.
These include income tax applied on withdrawals at the marginal rate of the beneficiary. This would create a system in which those inheriting pensions with the highest incomes pay more tax, while also offering simplicity given pension assets are already subject to income tax where the member dies after age 75.
Alternatively, the Government could apply a flat rate of tax on death to all unspent pension funds. AJ Bell said this would be “clear and simple” for people to understand and to plan accordingly.
Vahey added: “Rather than pressing ahead with what is clearly a flawed plan, the Treasury must consider pragmatic alternatives. There is still time for ministers to see sense and deliver a workable solution by April 2027, but first they will need to acknowledge the clear problems that the current proposals will create.
“It’s up to the Government to respond in a timely fashion to avoid pension savers making potentially damaging long-term decisions before they know the lay of the land. The Treasury now needs to work constructively with advisers, their clients and the pensions industry over the next two years to find a sensible and proportionate solution for all parties involved.”
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