New Pension Tax: What UK Families Need to Know

A recent proposal by HM Revenue & Customs (HMRC) may change the way pensions are inherited in the UK. At its core, the change could result in significantly higher tax bills for many who inherit pensions, with estimates suggesting an added burden of up to £13,000. It’s a move that might alter how we think about our retirement savings and inheritance.

The Current State of Pension Inheritance

Currently, the way it works is fairly simple:

  • If a person dies before the age of 75, the beneficiary (or person who inherits their pension) can withdraw money from the pension pot free of inheritance tax.
  • Additionally, the person who inherits the pension can take out money without paying income tax.
  • If the deceased person was over 75, however, the beneficiary has to pay income tax on any withdrawals.

What’s Changing? The New Proposal Explained

HMRC has suggested a few significant changes:

  1. Taxation on Inheritance: The new rule could mean an end to inheriting pension pots tax-free. Anyone with an income of at least £12,570 a year might face a tax bill when inheriting a pension.
  2. Changes in Withdrawals: Regardless of the age of the deceased, all withdrawals from an inherited pension would be subject to income tax. Financial advisers from True Potential estimate that, on average, their clients could end up paying £13,693 in extra income tax if this rule was in effect last year.

The Real Impact: Numbers and Analysis

If these changes come into play, their impact can be significant:

  • An individual inheriting a pension could end up paying nearly £30,809 in taxes if pushed into a higher tax bracket because of the inheritance.
  • Over 170,000 people in England, who passed away before the age of 75 in 2019, would have been affected by this proposed change.

But there’s more to it than just these numbers. Sir Steve Webb, former Pensions Minister, voiced concerns over how these changes are being introduced, suggesting the government is trying to make these significant alterations without adequate public discourse.

How Can You Protect Your Pension?

Despite the looming changes, there are strategies to consider:

  • Opting for Lump Sums: The proposed rules still allow for up to 25% of an inherited pension to be taken as a tax-free lump sum, provided it’s under the cap of £1,073,100.
  • Being Wary of Drawdowns: If the pension remains invested and is drawn as income, it would be taxed at the new owner’s rate.

Yet, experts like Steven Cameron from pensions group Aegon caution against hasty withdrawals. Taking lump sums may seem a way to dodge the tax, but the money then loses out on potential tax-advantaged growth. Plus, with annual caps on pension contributions (known as the annual allowance), one might not be able to reinvest a significant lump sum into another pension.

The Bigger Concerns: What Experts Say

There’s a consensus among financial experts that these proposals, while aimed at higher-value pension pots, will impact even those with modest pensions. The overarching sentiment is that this isn’t a move targeting the ultra-rich; it’s one that affects ordinary people.

Moreover, there are warnings about a potential domino effect. Gary Smith, a financial planner, suggests that the rule might result in larger inheritance tax bills in the long run.

Wrapping Up: The Road Ahead

It’s evident that the proposed pension tax changes are causing ripples of concern. As families are already grappling with soaring inheritance tax costs, with HMRC collecting over £7 billion in the last tax year, this potential change might add to their financial challenges.

It remains to be seen how these proposals will evolve and what final form they’ll take. But being informed is the first step in navigating the uncertain waters of future financial planning.