I have this morning published the next in my series of proposals that will make up the Taxing Wealth Report 2024.
In this latest note, I suggest that the inheritance tax exemption for funds that can be retained in a pension fund at the time of a person's death should be abolished. There is no logical reason why these funds should be capable of being passed to a person's heirs free of tax in some circumstances, most especially when they have already been accumulated tax free.
The summary of this report says:
Brief summary
This note suggests that:
- The current inheritance tax provisions that exempt from charge to that tax sums left in personal pension arrangements that have been undrawn at the time of a person's death should be abolished.
- These arrangements have been abused with consequence for horizontal and vertical tax equity in the UK.
- This abuse is widely known about and advised upon by UK financial services providers.
- Despite forthcoming panned changes to pension tax laws, this arrangement is likely to offer continuing opportunity for abuse in the future.
- On the basis of reasonable estimates, abolishing this exemption could raise maybe £1.3 billion in additional tax revenue per annum.
- This change would be easy to implement.
Discussion
There are some suggestions made within the Taxing Wealth Report 2024 that require quite a lot of explanation and justification. This suggestion is not one of them.
There is no inherent tax logic to a relief from inheritance tax that exempts from charge to that tax funds that have already been accumulated tax-free within a pension fund arrangement set up for the benefit of an individual person. If anything comes close to being described as a tax loophole, then this is it. Why it was created and with what intention does not really matter. What is known is that it is widely recommended and is likely to be widely used for precisely that reason. Even forthcoming changes in pension rules are not likely to eliminate all its appeal. This loophole has to be removed.
Cumulative value of recommendations made
The recommendations now made as part of the Taxing Wealth Report 2024 would, taking this latest proposal into account, raise total additional tax revenues of approximately £95.0 billion per annum.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
I have also wondered what the reason for this exemption from IHT might be. The only thing I can think of is that it was intended as the equivalent of the post-death benefit provided in a traditional DB pension in the form of the widow’s (dependant’s) pension. But most probably we shouldn’t be looking for a logical explanation.
As you say, people are widely advised to make use of this exemption, particularly since many pension providers insist people taking a DC pension by drawdown take professional advice.
I agree that IHT exemptions are an important area to scrutinise, particular with the total available IHT theshold (including main residence) being so high and politically difficult to reduce.
This makes sense.
One issue to consider is that UK personal pension schemes can be transferred to overseas pension schemes. Are there avoidance issues with that? Would it be practical to charge IHT on overseas pensions (which are likely to be a trust or the like, not explicitly owned by the deceased)? Should overseas transfers not be allowed, or should there be a charge on the way out?
Why allow such transfers?
I can’t understand how this exemption ever came into being. It makes no sense.
It’s not quite as egregious as it appears in that beneficiaries have to pay income tax at their marginal rate (which might or might not be 40pc) as they draw income. However, that does offer wiggle room (leave to grandchildren?) to avoid tax.
With lifetime allowance uncapped it will become a bigger issue over time.
Agreed
It seems to me to be quite bizarre.
I can understand transferring any remaining pension to a spouse on death or to maintain any dependant children but to just make it exempt from IHT under any other circumstances makes no sense.
I could understand allowing a pension to be transferred abroad if someone emigrates but only if they have done so and have a settled intention to remain abroad or are a non UK National
I’d guess this exemption came about somewhat accidentally, with the legal structure of pensions being trusts (or something similar?), not directly owned by the person whose pension it is.
It’s become more of an issue with the sheer scale of pension fund assets, and with allowing people to leave it all inside this tax-free wrapper instead of using it as, er, a pension.
You really think George Osborne did this accidentally?
That’s quite sweet if I might say so
No, I didn’t mean Osborne did it accidentally. He was quite deliberately turning them into tax-free inter-generational trusts for the wealthy.
I meant decades earlier, whenever personal pension funds were originally given special tax/legal status. When they were expected to be paid out within your (or your spouse’s) lifetime. And there was not yet a huge amount of wealth held inside them.
Understood