Rishi Sunak, the chancellor, was urged to use this month’s Budget to fix an “indefensibly generous” perk that allows wealthy pension investors to pass unused retirement money tax free to heirs.
The Institute for Fiscal Studies, an independent think-tank, said death benefit arrangements in defined contribution pension accounts were “very, very generous” and should be reviewed.
Rule changes in 2015 allowed any unused cash left in a defined contribution personal pension to be passed to beneficiaries and heirs tax free if the pension holder died before the age of 75.
More than 200,000 savers have transferred their future defined benefit (DB) pension benefits to a personal pension, many attracted by securing full control over access to their cash in these arrangements but also by the tax-advantaged death benefits.
Against a backdrop of squeezed public finances, Carl Emmerson, IFS deputy director, said the DC death benefits were “indefensibly generous” and should be reviewed.
“If you die before the age of 75, the entire pot can escape income tax entirely and there’s no inheritance tax either,” he said, speaking at a pension industry conference this week.
“With inheritance tax, people sometimes complain of double taxation. With this, it is not double taxation — there’s no taxation.”
Emmerson said the DC death benefits were “incentivising pension pots to be used as inheritance vehicles rather than for their traditional purpose of drawing a retirement income.
“This is an important one to fix soon because the longer you leave it in place, the longer people legitimately will say: ‘I’ll put money in my pension with the expectation that I could use that to give money to my heirs,” he said at the Pensions and Lifetime Savings Association conference.
“I think it is important to try and keep that toothpaste in the tube while you can.”
The remarks come as Sunak looks for ways to repair the nation’s finances after public spending soared during the pandemic. Last month he announced a £12bn annual rise in national insurance contributions to increase funding for the NHS and social care — with the rises due to take effect next April. He is under pressure to go further with tax rises in his autumn Budget.
The latest life data expectancy from the Office for National Statistics suggests most DC pension pots will not pass to heirs tax free. The ONS found life expectancy at birth in the UK in 2018-20 was 79 years for males and 82.9 years for females.
David Penney, director and chartered financial planner with PR&W, a City-based firm of advisers, believes that death benefits were always going to come under the chancellor’s microscope.
“If this perk is removed, I would expect it to be retrospective, as has been the case in the past with changes to pension death benefit taxation,” said Penney.
“All [DB transfer] advice should contain a caveat to say that the advice is based on current legislation, and we cannot be expected to have a crystal ball to predict tax changes. But in the case of DB transfers, a key reason for transferring could be made significantly less beneficial. Unfortunately, transferring is irrevocable, so the member might regret their decision.”
Under current rules, beneficiaries inheriting a pension pot from an investor who has died on, or after the age of 75, are required to pay income tax, at their marginal rate, on the payments they receive.