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  • Writer's pictureSara White

Shock plan to tax inherited pensions

Updated: Mar 21

In a slew of legislation issued this week, the government plans to change income tax rules for people who inherit pensions to make them liable for marginal rate income tax

Sara White, Editor, Accountancy Daily

Pensions experts Quilter is calling for urgent clarification of how the proposed tax change will work, particularly as the measure has only been briefly mentioned as part of new guidance on the removal of the lifetime allowance.

The announcement to charge tax on pensions benefit at marginal rates of tax from 6 April 2024 was made briefly in the guidance about how the lifetime allowance will work and was released as part of Legislation Day on 18 July. This follows the removal of the lifetime allowance cap which removed tax liability on larger pension pots in excess of £1.07m.

The document states that it will be changing the tax treatment of payments of uncrystallised and crystallised lump sum death benefits in the event a pension holder dies under age 75, charging tax at the marginal tax rate. Presumably this was included to offset the loss of tax from the removal of the lifetime allowance but the measure would capture all pension beneficiaries as currently set out.

Jon Greer, head of retirement policy at Quilter: ‘On face value, it appears quite significant changes to the tax treatment of beneficiary pensions were put forward in a relatively underhanded way under the guise of removing the lifetime allowance from April 2024. A single sentence at the end of a policy statement appears a rather odd way to announce a sea change in such a material aspect of the pensions tax regime.

‘It begs the question of whether the publication of this alongside the legislation was even intentional or whether it was a result of huge time constraints to release information by Legislation-day (L-day). Regardless, this is something that needs clarification sooner rather than later.

‘It would be odd for this to be how government chooses to announce such a big change, especially with a general election looming; it’s hardly a vote winner - quite the opposite you would have thought. There is no doubt that HMRC has been under pressure to get information out, but this is not actually a written policy of the Treasury or based on anything formally announced so it feels premature.’

The measure will affect people who are in receipt of an inherited pension benefit. If the amount is paid to qualifying persons, it will be counted towards the deceased member’s lump sum tax free limit, and the excess will be taxed at each beneficiaries’ marginal rate, HMRC said.

If the benefit is non-qualifying, it will be counted towards the deceased member’s lump sum tax free limit and the excess will face a basic rate income tax charge under Part 9 ITEPA. If the payment is made outside of the two-year period and the special lump sum death benefit charge (SLSDBC) currently applies in this scenario, then the individual would continue to be subject to this charge

‘On the face of it the changes put forward would subject many more people to taxation, impacting beneficiaries of members who die pre age 75 who left uncrystallised (unused) funds in their DC pension pot,’ Greer warned.

‘Currently such beneficiaries can choose to receive an income either by designating to drawdown or purchasing a beneficiary annuity and receive that income tax free.

‘If the announcement was intended, the government want those beneficiaries to pay marginal rate tax from next tax year. This will impact any beneficiary who chooses beneficiary drawdown or annuity regardless of the size of the pension fund the member had accrued during their lifetime. It’s a sea change in tax treatment and could have a large political impact ahead of an election one would have thought.’

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