Pensions should be subject to inheritance and income tax, IFS claims

Retirement pots should be included in the value of estates at death for estate tax purposes, according to the Institute of Fiscal Studies’ latest report, “Death and Taxes and Pensions.”

Basic income tax rates could also be levied on any funds that remain in retirement upon death, the investigative body added.

“The tax system treats funds that remain in a pension upon death extremely favorably,” the IFS said.

According to the IFS, subjecting pensions to inheritance tax would generate “significant” revenue for the government over time and remove the “perverse incentive” to prevent a pension from being used to fund the retirement.

Currently, if someone dies before age 75, the funds left in their retirement will completely escape income tax.

Income tax relief is given when the money is put into the pension, and there is no income tax when the money is withdrawn.

In addition, any funds that remain in a pension upon death, at any age, are generally not subject to estate taxes.

According to the IFS, “This results in the bizarre situation of pensions being treated more favorably by the tax system as a bequest vehicle than as a retirement income vehicle.

“As such, there is a great incentive for those who can, to use non-retirement assets to fund retirement while preserving their pensions for bequests.”

The IFS said private defined-contribution pensions are “a particularly tax-advantaged vehicle for bequeathing money to children and other heirs.”

The report gives an example of a couple being able to pass on an estate of more than £3 million tax-free under the current system.

The IFS added: “If the funds held in retirement pots then have to be subject to income tax – reducing their effective value – it would be appropriate for 80 percent of these funds to be counted for estate tax purposes.”

On the potential income benefits of subjecting people’s pension pots to inheritance tax, the IFS said: ‘Short-term income would be limited because few of those who die today leave pension pots.

“But if the generation benefiting from pension freedoms – those retiring after April 2015 – were to die with their entire pension pot intact, we estimate that this would mean the equivalent of £1.9bn a year (in today’s terms) in additional income from would result in inheritance tax.

“This increase would be substantial, representing an increase of about a quarter in the size and return of the inheritance tax.”

It added: ‘The rate of return is very sensitive to the rate at which pensions are phased out before death: if half of current pensions were left intact at death, the rate would fall to £0.9bn.’

The IFS said the proposed reforms would provide “more coherent” tax treatment of money left in someone’s pension when they die.

The IFS also said the proposed reforms should be implemented as soon as practicable to reduce the extent to which individuals have saved into a pension in the mistaken expectation that they can bequeath these funds under current “generous arrangements.” .

The reforms proposed by the IFS would raise both estate and income taxes.

The IFS said: ‘A government that does not want to increase the overall burden of these taxes could use the resulting revenue to raise the thresholds and/or lower the rates of those taxes. Combined, this would improve the economic efficiency and fairness of the tax system.”

The report claims that additional revenue raised could also be used for public services, such as adult social care and the NHS.

What do experts think of the proposed IFS reforms?

Jon Greer, head of pension policy at Quilter, said: “Ending the tax treatment of death pension pots on the grounds of ‘fairness’ only makes the situation more ‘fair’ for the Treasury, not necessarily for families – especially for those who have a loved one. can lose an at a relatively young age where the financial impact can be significant.

‘Changing the rules could also have some unintended consequences, such as prompting people to withdraw their tax-free lump sum earlier than they normally would, potentially reducing the total amount they have available for retirement.

Overall, the foregone revenue to the Treasury from these policies may not be significant compared to other areas of government spending, but could have a very positive impact on a significant number of families who do not have high incomes or fit into some of the extreme examples highlighted.’

He added: “I know losing a loved one is already a difficult and emotional time and having to worry about the financial ramifications of that loss can add to the stress. The tax-free nature of a pension pot in the event of a young death can be a much-needed financial support for these families.

‘Given that IHT thresholds have recently been frozen for a further two years at the Autumn Declaration, netting the Government a further £1bn, mainly due to property, more and more people will be paying estate taxes anyway. These additional changes to pensions would push even more people to pay what is often touted as one of the country’s most hated taxes.”

Helen Morrissey, senior pensions and pensions analyst at Hargreaves Lansdown, thinks a possible reform of the treatment of death pensions “could encourage people to use their pensions to secure a secure lifelong income”.

But she added: “We also need to consider whether these proposed changes will be a barrier to people trying to provide for their families.

“For example, someone who dies before age 75 can still support a young family and their retirement can be viewed as a life insurance policy rather than an inheritance tax vehicle.”