Like many people, took advantage of the change in pension laws and transferred out of a final salary scheme. For me the main drivers were to leave this to my children and have control over the access of it.
I now have a healthy lump sum in a Sipp. I am not married and therefore only have a single person’s inheritance tax allowance, currently £500,000 maximum. I understand that at present Sipps fall outside of the inheritance tax calculation.
I have a property, potential inheritance and other funds, including my personal pension. I previously read that for inheritance tax purposes it was best to leave my pension untouched if possible and spend other monies first, which I intended to do. I am nearing 60 and plan on retiring over the next five years.
Estate planning: Will the Government scupper my plan to leave a pension pot to my children free of inheritance tax?
The above plan would solve any potential inheritance tax issues and I felt very comfortable with everything I had put in place.
But recently I read that the government is looking at now including these pensions in the inheritance tax calculation, which for me and many others would be a disaster.
I know you don’t have a crystal ball but can you help put my mind at ease? What is the likelihood of this, what effect would it have, and what steps could I then take regarding my inheritance tax issue?
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Steve Webb replies: When it comes to pensions and inheritance, there are two taxes to think about – income tax and inheritance tax (IHT).
I’ll deal briefly with the income tax rules for those who inherit a pension, before moving on to IHT which is your main concern.
In most cases, if someone dies and passes on a modern ‘pot of money’ type pension, the income tax position depends on whether the death occurred before the age of 75 or not.
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If you inherit a pension pot from someone who died before 75, you can take the money out tax-free. If they died aged 75 or above, you pay income tax at your normal rate when you take money out.
Inevitably there are a few exceptions to this general rule. You can read a more detailed account of the income tax treatment of inherited pensions on the gov.uk website here.
Turning now to IHT, the basic idea is that in most cases an inherited pension pot would not be counted as part of the estate of someone who has died.
Provided that the people administering the pension (trustees and so on) had discretion over who to make the payment to, then the value of the pension would be excluded when working out any IHT due.
Some people have argued that these tax rules are unnecessarily favourable. They say that there is no reason why people should be able to inherit a pension free of income tax, and no reason why inherited pension wealth should be more favourably treated for IHT purposes than other forms of inherited wealth.
Amongst the most vocal critics have been the Institute for Fiscal Studies, which last month published a report arguing that the current rules are ‘exceptionally favourable’ and calling for the gradual introduction of IHT on inherited pension wealth.
As you say, although I don’t have a crystal ball, my instinct is that the current government is unlikely to make a change of this sort.
First of all, we are probably only around 18 months from a General Election and a government that is already struggling in the polls might think quite hard about making a change which could be electorally unpopular.
Second, assuming that the change was going to be phased in, such a reform would be the worst of all worlds from a political point of view – one which raises little money for the government up front but generates all the flak on day one.
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Third, in recent years we have seen Conservative Chancellors make various changes to reduce the burden of tax on inheritance, including the residential nil rate band (which I see you expect to benefit from).
The Government may feel that it is simply ‘not Conservative’ to increase death taxes, especially on the estates of those who have been prudent and saved in a pension.
In short, although the Government is likely to be looking for sources of funds to meet the cost of public services and to reduce borrowing, this sort of change would probably not work at this point in the electoral cycle.
Once we have had a General Election, it becomes much less certain what a new government would do in this space, and especially if that government was of a different political colour.
But even in that scenario, there could be considerable political cost to a change of this sort and relatively little extra revenue coming in as a result.
Ask Steve Webb a pension question
Former Pensions Minister Steve Webb is This Is Money’s Agony Uncle.
He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.
Steve left the Department of Work and Pensions after the May 2015 election. He is now a partner at actuary and consulting firm Lane Clark & Peacock.
If you would like to ask Steve a question about pensions, please email him at firstname.lastname@example.org.
Steve will do his best to reply to your message in a forthcoming column, but he won’t be able to answer everyone or correspond privately with readers. Nothing in his replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.
Please include a daytime contact number with your message – this will be kept confidential and not used for marketing purposes.
If Steve is unable to answer your question, you can also contact MoneyHelper, a Government-backed organisation which gives free assistance on pensions to the public. It can be found here and its number is 0800 011 3797.
Steve receives many questions about state pension forecasts and COPE – the Contracted Out Pension Equivalent. If you are writing to Steve on this topic, he responds to a typical reader question here. It includes links to Steve’s several earlier columns about state pension forecasts and contracting out, which might be helpful.