Date09 Oct 2023
One of the announcements in March 2023’s Budget that was met positively in some quarters was the abolition of the pensions lifetime allowance (LTA) charge.
However, in somewhat of a surprise turn, a policy paper was published by the Government on 18 July which has added an important caveat for those who inherit a pension from someone who dies before the age of 75.
Scheduled to take effect on or after 6 April 2024, the inheritance of an appropriate pension pot would now be subject to income tax. In many cases this will be at the recipient’s marginal rate.
This would have a far reaching impact and mean an increased tax charge for a number of individuals across the UK. 75 or under is a relatively young age at which to die these days, so in many cases this will be an additional tax burden for relatives, at a time when they are grieving the untimely loss of a loved one.
Since reforms in 2015, those who inherit a defined contribution pension from an individual who died under the age of 75 were often able to receive a lump sum tax-free. There was also the option to regularly withdraw from the pension pot whilst the funds stayed invested. The planned change aims to align the rules with the current regulations for individuals who inherit pensions from someone aged 75 or over at the time of their death. However, in some positive news, it appears that the ability to use the deceased person's unused lump sum allowance, which can be up to £268,275, will continue to be allowed. This lump sum will however no longer be index-linked to inflation.
The Lifetime Allowance was introduced in 2006, and originally at £1.5 million. It has gone up and down with successive Governments. As of the 2022/2023 tax year, the lifetime allowance was £1,073,100.
Breaching the allowance would mean tax penalties of 55% if the excess was taken as a lump sum, and 25% (plus income tax) if taken as income.
The Chancellor, Jeremy Hunt, announced earlier this year that the LTA will no longer apply.
The abolition of the LTA was part of the Government’s agenda to keep people in work and discourage some peoples’ plans for early retirement.
In most cases, any pensions you have can be passed outside of your estate and so won’t be subject to Inheritance Tax. However, for this to be the case, the pension scheme administrator would need to have discretion as to who the benefits are paid to. (This can be a complicated issue so if you are unsure discuss it with your financial adviser.)
Other assets left when you die, such as cash or savings, even if they were originally part of your pension pot, will be part of your estate for Inheritance Tax purposes.
When this increased income tax requirement for pensions is combined with a widening inheritance tax (IHT) catchment more generally, there is a possibility of a substantial hit for many families.
Despite high levels of inflation for a sustained period of time, the threshold for IHT has been frozen at £325,000 until April 2028. By this point, it will have been at the same level for seven years, leading to a regularly increasing number of people falling into its scope.
For estates worth over this £325,000 threshold, there’s a 40% tax-take in normal circumstances. Although the threshold does increase to £500,000 when a home is given away to children or grandchildren.
There are persistent calls for Government intervention and a raising in the thresholds, or even an abolishment altogether. However, with no change seemingly forthcoming, it’s important that families are efficiently planning for any eventuality to ensure the impact is minimised.
It's important to note that the policy paper provides an overview of the objectives and is not yet draft legislation. Therefore, it remains to be seen how the changes will be implemented and whether any transitional rules will be put in place. As this is a significant upcoming change in the tax treatment of beneficiary pensions, swift clarification from the Government is needed.
It is recommended to begin contemplating the potential ramifications for any pensions you have received and whether it would be beneficial to take proactive measures to optimise your tax position before 6 April 2024, when the new regulations are expected to come into effect.
If you would like to discuss your specific circumstances, please get in touch with a member of our specialist team.
Information correct at time of publishing, but may be subject to change in future. This article is for general information only and is not intended to be advice to any specific person. You are recommended to seek professional advice before taking or refraining from taking action on the basis of the contents of this article.
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