Will I have to pay income tax on an inherited pension?

23 November 2023

Estate planning involving pensions is a tax-efficient strategy for the beneficiaries. But this could be set to change, because HMRC have issued a policy paper suggesting taxing inheritors on income – even if the benefactor was to die before reaching 75 years of age.

Find out what this means for your wealth management plans, and why it’s a good idea to contact us if you have any concerns.

the current scenario

Currently, existing regulations state that if an individual dies before reaching 75 years of age, beneficiaries can inherit the pension pot without incurring any income tax. They are also exempt from inheritance tax (IHT).

This current scenario makes pensions one of the most attractive benefits of inheritance planning, as it offers tax advantages and is a source of tax-free income for the beneficiaries.

what’s changing?

In July, HMRC published policy documents that included draft legislation to abolish the pension lifetime allowance, and the associated income tax charge, in 2024.

The Government previously announced this as part of its Budget Day measures, in a bid to lure people aged 50 and over back into work.

NEW LIFETIME LIMITS

Two new lifetime limits have been proposed by the Government.

  1. Lump Sum Allowance: this would be set at £268,275 – a quarter of the current £1,073.100 lifetime allowance.
  2. Lump Sum and Death Benefit Allowance: this would be set at £1,073,100 and incorporate tax-free lump sums when taken while alive, and lump sums paid on death.

POTENTIAL IMPACT ON PENSIONS AND INHERITANCE TAX

Among the policy documents issued in July, there were suggested changes to pension tax. Included was a suggestion that from 6 April 2024, inherited pensions would ‘no longer be excluded from the marginal rate income tax’ of the inheritor.

This would mean any income drawn from an inherited pension pot would become subject to income tax. The rule would align with the current tax position, where beneficiaries of pensions where the member dies over the age of 75.

confusion

If the proposals go ahead, then inherited pensions that haven’t been accessed and are taken as a lump sum within the new proposed Lump Sum and Death Benefit Allowance limit will remain tax-free.

But, if the beneficiary chooses to access the pension as income, the whole withdrawal could be taxed as income.

Adding this complexity could result in more beneficiaries choosing lump sum withdrawals, even when an income is more suitable for their requirements.

WHAT DO THE EXPERTS THINK?

Some financial experts and former pensions ministers have stated that changes as significant as this should have been discussed more beforehand, and announced publicly. Such lack of clarity has understandably caused confusion among some savers, which leads to uncertainty. If pension savers are to navigate new complex rules, it’s hoped that new, clear and transparent guidelines will be issued.

Fortus Wealth Management are monitoring the situation, and will issue further advice as the story develops. We’re on hand for all your plans for the future, so get in touch if you need help with estate planning or any other aspect of wealth management. Call today on 0330 173 4781.

For Pensions, Investments, Mortgages, Protection and Insurance, Fortus Wealth Management (North) Ltd (FRN 985590)  (Company Number 14218497, registered address Equinox House, Clifton Park, Shipton Road, York, YO30 5PA) is an appointed representative of Julian Harris Financial Consultants (FRN 153566), which is authorised and regulated by the Financial Conduct Authority. The performance of your investments is subject to risk(s). Its performance may fluctuate based on movements in the market and economic condition(s). Capital at risk. Currency movements may also affect the value of investments. You may get back less than you originally invested. Past performance is not a reliable indicator of the future performance. Tax treatment is based on individual’s unique circumstances.

 

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