Death tax on pensions ‘a real threat’ under Labour

Death tax on pensions ‘a real threat’ under Labour

Death tax on pensions ‘a real threat’ under Labour

Labour claims the Tories will do more to undermine ‘pensioner economic security’ – Kirsty O’Connor/PA Archive

A pensions death tax is “a real risk” under Labour, industry insiders have warned.

Inheritance tax is currently not charged on pensions – a break that policy experts describe as “extremely generous”.

The tax break is also now much more valuable after Chancellor Jeremy Hunt abolished the tax-free lifetime allowance on pension savings.

Pension policy experts now say it is likely that shutting down the tax loophole will be a “soft target” for Sir Keir Stamer’s party should it win next month’s general election.

Labour has denied that a pension death tax is “party policy” and said the Tories will do more to undermine “pensioner economic security”.

The party was quick to pledge to re-introduce the £1.07m lifetime allowance after the Tories scrapped it last year. In January, Labour committed to a review of the current pension system if elected.

Pensions experts have said that one change that could come under the scope of the review is bringing pensions within the scope of inheritance tax.

Currently, if you die before the age of 75, then the lump sum from your pension is tax free – for anyone who dies after this age, income tax applies at the point it is withdrawn.

Tom McPhail, public affairs director at financial consultancy The Lang Cat, said the tax treatment of pension death benefits was “extremely generous” at present.

He said: “As a consequence, it is currently a well established principle of financial planning that those seeking to minimise their inheritance tax liability can use their pensions to shelter their wealth.

“It seems a very soft target for a Labour government which is ideologically inclined towards wealth taxes and which has already taken most other tax rise options off the table.

“They may well move into a flat rate and bring in some additional form of death tax on pensions such as making them liable for inheritance tax…There is definitely a real risk that this [a pensions death tax] could happen [under Labour].”

Shadow chancellor Rachel Reeves previously championed a flat 33pc rate of pensions tax relief, back in 2016.

Bringing pensions under the scope of inheritance tax would raise £200m in the current tax year, according to the Institute of Fiscal Studies (IFS).

The IFS reckons this figure could rise to around £400m in 2029-30, before reaching up to £2bn “in the coming decades” as pension pots continue to grow in size.

Tom Selby, director of public policy at investment broker AJ Bell, said politicians would be terrified about doing something which would inevitably be portrayed as a “death tax”.

He added: “However, it is true that changes made by former chancellor George Osborne in April 2015 mean pensions are extremely tax efficient on death and can – in some circumstances – be passed on completely tax-free.

“It is entirely possible, but not inevitable, that a future government will view this as overly generous and look to raise cash by increasing the amount of tax applied to pensions on death.

“Were this to happen, the government would need to consider exactly how to deal with people who have taken decisions about contributing to a pension or transferring a pension based on the tax rules today.”

In particular, Mr Selby said, some people will have transferred a defined benefit pension to take advantage of defined contribution death benefits rules.

He said: “If these were changed, those who face a swingeing tax hit on death as a result might understandably feel angry at the fact the goalposts have been moved.”

Other options at Labour’s disposal, according to experts, include applying a tax charge to the value of the pension left on death after the age 75.

Prior to the introduction of pension freedoms in 2014, where a pension was left on death after the age 75, the value was subject to a tax charge of 55pc. This would mean the beneficiary received only 45pc of the value.

So, if someone died with a pension fund of £200,000, a tax charge of £110,000 would have been deducted and the beneficiary would only receive £90,000.

Gary Smith, partner at wealth manager Evelyn Partners, said: “A measure like this would encourage those with pensions to withdraw as much income as possible from their pensions before their 75th birthday, as the income tax of 20pc, 40pc or 45pc would be below the potential 55pc tax on death post age 75.

“This would generate additional income tax revenue for the Treasury that they don’t currently receive as pension savers don‘t need to draw an income and can leave the full value to their beneficiaries on death.”

A third option, Mr Smith said, would be for a future chancellor to provide an individual with a pensions nil rate band of £325,000 which could be passed to a beneficiary completely tax-free – with any value above that subject to a 40pc tax charge.

He said: “This would effectively match the inheritance tax position on other assets, but could be unfair on those who die young.”

Labour has said it plans to close loopholes in the non-dom tax status to fund its NHS reforms, impose VAT on private school fees to fund more teachers in state schools, and use the proceeds of economic growth to fund its other policies.

But this week, MoneySavingExpert founder Martin Lewis accused Labour of “living in fairy-tale land” and said “growth won’t cut it”.

A Labour spokesman said: “(A pensions death tax) is not Labour policy. Labour will always protect pensioners who have worked hard and paid into the system. We will guarantee the triple lock and we won’t stand by as the Tories rip apart national insurance contributions and risk the state pension or the NHS.”

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