IHT reforms – what could they mean for pensions?

Over the last few weeks there’s been a fair amount of noise regarding IHT reforms. First we had the Office of Tax Simplification (OTS)’s call for evidence, and more recently the Intergenerational Commission (IC)’s ‘Passing on’ report on options for reforming IHT. Whilst both papers are looking at the wider IHT picture, there are implications for pensions.

Pensions only get a brief mention in the OTS report, under the heading ‘other areas of complexity’, with views being sought on issues around applying the rules and suggested improvements.

The requirement for trustees to use discretion when distributing death benefits from a pension certainly falls into the complex camp, and can cause huge issues for providers. Even in the majority of straightforward cases where the expression of wishes is up-to-date and uncontested, there are processes required to ensure this is the case, and this can delay distribution.

A significant minority are more problematic, and all too often the provider is put in the middle of family disputes in a no-win situation where somebody is always going to be unhappy, whatever the final decision. Would it not be far simpler to have a carve-out for pensions that means benefits can be paid free of IHT without the need for discretion? In that way clients could be certain their wishes would be followed, admin costs for paying out death benefits could be significantly reduced and benefits could be paid out much quicker.

Turning to the IC report, a number of radical new proposals are tabled. They advise complete abolition of IHT as we know it, and replacing it with a ‘Lifetime Receipts Tax (LRT)’ whereby you get an allowance of £125,000 (indexed to inflation), and each time you receive an inheritance you use some of it up. So, like a LTA for receiving inheritance. Once it’s all gone you pay tax at 20% up to £500,000 and 30% on any receipts above that.

They also specifically target pensions, and recommend that death benefits should be liable to the new LRT (or IHT under the current system) for all except spouses. They also believe all recipients of pension death benefits should pay Income Tax, regardless of the age of the deceased. So, potentially any non-spouse beneficiary could be liable to Income Tax, LRT/IHT and an LTA charge on death benefits. On the positive side, the need for discretion would disappear if LRT/IHT was always payable, but it’s a steep price to pay.

The current death benefit rules are particularly generous. There was general shock when they were announced, and a feeling that they were too good to last. There are clearly tax planning opportunities under the current regime, and incentives for pensioners to use up other assets before touching their pension pots, so it’s no surprise that changes are recommended.

Only time will tell if any of the proposals see the light of day. More meddling with the rules does nothing to help the cause of increasing consumer confidence in pensions, but the biggest losers would be wealthier individuals. Whilst they are not the concern of the IC, they may well be for the current government.

Senior Technical Consultant

Lisa is an Economics graduate who has been in the financial services industry since 2003. Prior to joining AJ Bell in 2014 she spent nine years working in senior technical and consultancy roles at a major SIPP and SSAS provider. Lisa is part of our Technical Team, responsible for providing regulatory and technical analysis to the business and outside world. She is also a regular speaker at adviser events.