Experts are warning that Brits face a potential “double tax hit” on October 30, as Reeves looks to plug what Labour now says is a £40billion black hole in the nation’s accounts. If she does, it will hit grieving families doubly hard.
It’s now widely assumed that Reeves will impose inheritance tax (IHT) on our pensions in next week’s Autumn Budget. That would be a major change.
Today, people can pass on unused defined contribution pension pots to loved ones free of IHT when they die.
Many better off retirees take advantage by leaving their pension to grow while drawing retirement income from other forms of savings, such as Isas, which are subject to IHT.
That way if they have money left in a pension when they die, they can pass it on free of IHT.
They’ll have to rethink their plans if Reeves makes unused pension liable to a potential IHT charge at the standard rate of 40%.
That’s not the worst of it.
Jordan Gillies at wealth manager Saltus has warned that imposing IHT on pensions could potentially see families pay tax not once but twice on the same money. “This could create a double tax hit for beneficiaries.”
So how does that work?
Currently, if someone dies before age 75, loved ones inherit their defined contribution pension entirely free of tax.
However, if they die from age 75, beneficiaries are liable to pay income tax on the money.
The inherited pension is added to their total earnings for that year, and taxed at their marginal rate. Many could therefore hand 40% or 45% of the remaining pension to HMRC.
Let’s see how that could work in practice. Imagine somebody dies at 75 with £100,000 of pension above the IHT nil-rate band, all therefore taxable at 40%.
If Reeves imposes IHT on pensions, they would hand £40,000 to HMRC.
This would leave the family with £60,000. Now let’s say that goes to a child and is charged higher rate income tax of 40%.
The child will hand another £24,000 to HMRC.
They will be left with just £36,000 out of the original £100,000 of pension. The Treasury has taken £64,000 of the money.
That’s an effective tax rate of 64%. Which is brutal. And for all we know it could come into force from the end of the month.
Worse, it doesn’t end there.
This isn’t the only potential double tax whammy families face as the Budget looms. As I’ve warned before, some families could end up paying both capital gains tax (CGT) and IHT on the same asset on death, depending on what Reeves does.
Today, if someone has made a capital gains, any CGT liability is wiped out on death. Instead, only IHT applies. However, the Institute for Fiscal Studies (IFS) has called on Reeves to axe CGT “forgiveness” on death.
If Reeves listens, families could pay CGT on assets such as second homes, buy-to-lets and non-Isa shares on death. Then they’ll pay IHT on what’s left.
IHT tax receipts are already at a record high. Nicholas Hyett, investment manager at Wealth Club, said it is turning into an “absolute cash cow for the Treasury”.
He said removing the IHT exemption on pensions would be damaging. “Constantly changing the rules puts people off saving in a pension, whether they are rich or poor.”
Taxing assets once on death is painful enough. But taxing them twice is brutal.
