The Budget announcement on inheritance tax is a potential disaster for pensions.
This will mean less cash inflows, more early withdrawals, less pension fund investment in higher-yielding long-term assets and more retirees relying on government benefits.
This is eerily reminiscent of Gordon Brown’s 1997 removal of dividend tax credit from UK pension funds, which, like this budget, met with little industry opposition at the time.
It took several years to recognize this fatal blow to traditional final salary defined benefit (DB) pensions.
The end of the Inheritance Tax (IHT) exemption for unspent pensions could be just as damaging to the defined contribution (DC) schemes that replaced the once successful private sector DB arrangements, undoing George Osborne’s brilliant 2015 freedoms boost.
Tax grab: Chancellor Rachel Reeves said in the Budget that from April 2027 pensions will no longer be exempt from inheritance tax
This removed requirements for DC pensions to buy annuities (where insurers can pocket the pension funds of those who die, leaving nothing to heirs) or buy expensive withdrawal funds with a 55 per cent death tax.
After 2015, people could take control of their pensions, feeling secure in contributing more for long-term investment and withdrawing money only when they want to.
The tax system encouraged people to spend any other savings first, saving retirement funds for their 80s and 90s – which was the original purpose.
Removing the IHT exemption takes us back to the bad old days. There may be some sympathy for the millionaires, but those near the middle are the hardest hit.
Most people underestimate their life expectancy, worry about dying relatively young, don’t want annuities, and would rather not lose most of their retirement investments to the taxman.
This is not just a 40 percent tax on unused funds. It’s far worse.
If the Chancellor’s proposals go ahead in 2027 as planned (and I hope they don’t, so please respond to the consultation), those who inherit pensions from anyone who dies over 75 face income tax on withdrawal.
So HMRC takes 52 per cent, 64 per cent or 67 per cent of the inherited fund, depending on the tax brackets. This is more like confiscation than taxation.
Consider someone with a £500,000 pension fund (which could buy around £20,000 of annual income from an index-linked pension annuity).
After taking tax-free cash, the remaining £375,000 could be withdrawn at 20 per cent tax, keeping annual income below £50,271, the 40 per cent threshold.
If they have a full state pension of £12,000, that leaves them with around £38,000 a year available at basic rate tax. The fund could disappear within ten years.
A £400,000 fund could be gone in less than eight years. People on average incomes who start their withdrawals at age 55 would exhaust their funds much sooner.
Anyone already past State Pension age can now immediately consider withdrawing as much as possible to avoid a huge death tax loss.
Commentators have not yet realized how damaging this change to IHT is. The government is planning further pension revisions, creating even more uncertainty for long-term planning, again undermining pension confidence.
Millions are at risk of poverty in later life. The UK economy and markets will suffer as there is less investment in the long term. It’s time to wake up.
Don’t destroy DC pensions, instead use them to fuel growth.
