The UK’s Autumn Budget has introduced significant proposals concerning the taxation of pension funds after the death of a member. These changes, if implemented, could have far-reaching implications for pension savers, their beneficiaries and estate planning strategies. Here is a breakdown of what has been proposed and what it means for individuals and families.

Current system: a recap

Under the existing rules, pension funds are considered a tax-efficient vehicle for both retirement planning and inheritance. If a pension holder dies before the age of 75, their beneficiaries can typically inherit the remaining funds tax-free, whether as a lump sum or as income. After age 75, the inherited pension is taxed at the beneficiary’s marginal income tax rate. Crucially, these funds are outside the scope of inheritance tax (IHT), making pensions a valuable tool for wealth preservation.

What’s changing?

The Autumn Budget proposal introduces an IHT charge on pension funds passed on after death. This could effectively remove the “double protection” that pensions currently enjoy from both income tax (in some cases) and inheritance tax. Key points from the proposals include:

  1. Application of inheritance tax: Pension funds left to beneficiaries could now be treated as part of the deceased’s estate for IHT purposes, subject to the standard 40% tax rate above the £325,000 nil-rate band.
  2. Broad scope: The proposals are expected to apply to defined contribution (DC) pensions, which are currently the most common type of pension. Defined benefit (DB) pensions, which often do not leave large lump sums on death, might be less affected.
  3. Potential exemptions: Discussions around whether funds used to provide ongoing income for a spouse or dependent might be exempt from the tax are continuing.

Implications for savers

The introduction of IHT on pension funds could significantly alter the financial planning landscape:

  1. Estate planning: Pensions may lose some of their appeal as a tax-efficient inheritance tool, prompting savers to explore alternative strategies, such as gifting wealth during their lifetime or using trusts. Pensions could be subject to a 40% IHT charge and if not taken within 2 years of death, an income tax charge in addition when drawn.
  2. Shift in withdrawal strategies: Individuals will now need to seriously consider drawing down their pensions earlier in retirement rather than leaving funds untouched for inheritance purposes. Maybe gift the tax-free lump sum and hope to survive seven years and use the pension.
  3. Increased complexity: Beneficiaries could face more administrative burdens and potential tax bills when inheriting pension funds, particularly for high-value estates.
  4. Impact on retirement savings: The proposals might discourage some individuals from maximising pension contributions, especially if the perceived inheritance benefits are reduced.
  5. Executors: Executors will have an obligation to liaise with pension fund administrators to determine the tax payable. Also, as forming part of the estate, they will need to consider the effect on the residential nil rate band.

What can savers do now?

While the proposals are not yet finalised, it’s important to take proactive steps to safeguard your financial future:

  1. Review your pension plan: Understand how your pension is structured and how these changes could affect its value for your beneficiaries.
  2. Consult a professional: A professional accountant or financial adviser can help you assess your options, such as diversifying your retirement savings or updating your will and beneficiary nominations.
  3. Stay informed: Keep an eye on updates as the proposals progress through Parliament. The details may change, and exemptions or transitional arrangements could be introduced.

Summary

The proposed changes to pension taxation mark a significant shift in the UK’s approach to retirement and inheritance planning. This may reduce the level of funds held within the pension wrapper and also increase spending as members will be more likely to try to spend their pensions before death. Now is the time to evaluate your financial plans and prepare for a potentially more complex and tax-heavy inheritance landscape.

For any enquiries regarding the taxation of pension funds, please do not hesitate to contact Peter Tuffin at p.tuffin@uhy-uk.com or your usual UHY private client adviser.

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