Labour ‘death tax’ warning as Reeves lines up inheritance tax raid on your pension
Pensions have a number of tax perks and one of the most attractive comes right at the end, as you can pass unused pot to loved ones free of inheritance tax (IHT). That may not survive the general election.
When you die, all of your assets, including savings, Isas, family home, car and pretty much everything else must be totted up to work out the value of your taxable estate on death. But not your pension. It can be passed on free of inheritance tax and Labour Party advisers do not like it.
The ability to pass on pensions free of IHT may not last much longer amid, as rumours grow that Labour leader and shadow chancellor Rachel Reeves may axe it if Labour wins the election on July 4.
Right now, they’re keeping tight lipped about their plans, although party sources have suggested Labour could hike between 10 and 12 taxes in total.
That is a staggering number and could include a so-called "pensions death tax", as Reeves’ policy advisers have been aggressively pushing for extra taxes on pensioners.
We may not know until Labour publishes its manifesto or Reeves delivers her Autumn Statement later in the year, causing uncertainty for families who have been making plans to pass on pension free of IHT.
Pensions have been excluded from IHT for years, said Andrew Tully, technical services director at advisers Nucleus Financial. “Scheme trustees or administrators usually have discretion over who gets the death benefits. As nobody has an absolute ‘right’ to those benefits, there is no IHT.”
Few benefited from this because most savers were obliged to use their entire pension to buy an annuity at retirement, leaving nothing left over.
That changed in April 2015, when the Tory party’s pension freedom reforms ended the obligation to buy an annuity with your savings at retirement.
Today, three quarters of retirees leave their pension invested via drawdown, withdrawing cash as required.
If they have any pension left when they die, it can be passed onto grown-up children or other beneficiaries free of IHT.
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Loved ones can take the money completely tax-free if the policyholder dies before age 75. If they die afterwards, loved ones will be liable to pay income tax on the money at their marginal rate.
Tully said pensions are now a hugely tax efficient way of passing wealth onto family, but "arguably isn’t their primary purpose”.
And that leaves them vulnerable to a Labour tax raid.
While most pensioners need every penny they have for themselves, those with larger retirement pots often spend other forms of savings first, such as cash deposits and Isas. "This way they can retain some pension wealth to pass on to family in a tax-efficient way," Tully said.
Families who have done this would be furious to discover they'd face an inheritance tax bill after all.
Reeves has two options, he added. She could either make beneficiaries pay income tax on inherited pension even if the policyholder dies before age 75.
Alternatively, she could make leftover pension liable for IHT, regardless of the age the policyholder died.
Tully warned that people are not saving enough for retirement and anything that discourages them would be a bad move. “Whoever wins the election should be encouraging more people to save for later life, rather than deterring them."
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Tom Selby, director of public policy at AJ Bell, thinks it unlikely that Reeves will reveal her hand before the election. "Politicians will be terrified about doing something which would inevitably be portrayed as a ‘death tax’.”
If any politician did introduce a pensions death tax, they could they face a backlash from savers who been following existing rules. "They may understandably feel angry at the fact the goalposts have been moved.”
Selby said saving for retirement is a long-term task that takes decades, and people need certainty. “The sheer amount of changes to both the annual and lifetime pensions allowance over the last 14 years have left many unsure which way is up."
Labour also plans to restore the pensions lifetime allowance, which imposes a 55 percent tax charge on those with larger pension pots.
Selby said this would spread more confusion, and put more people off saving, which is surely the last thing any government wants. Yet it could soon happen.
Labour needs to tell us its tax plans. Before the election, not afterwards.
