Overview
IFS researchers set out proposals that would make the tax treatment of pensions at death fairer and more economically efficient. The revenue raised by moving to a more sensible system, even if relatively modest in the near term, could be substantial in the longer term.
The report identifies the following problems:
- Inheritance tax. Any funds that remain in a pension at death (at any age) are not subject to inheritance tax. As such, there is a substantial incentive, for those who can, to use non-pension assets to fund their retirement while preserving their pensions for bequests. To give the most extreme example: a married couple could each leave £1,073,100 in their pensions free of inheritance tax (i.e. £2,146,200 in total), whereas if they instead bequeathed the same total amount in savings there could be a total inheritance tax bill of at least almost £600,000.
- Income tax. Pension contributions are already free from income tax. When someone dies before age 75, funds remaining in their pension escape income tax entirely. But income tax is payable on funds remaining in a pension when death occurs at or after age 75. For a basic-rate taxpayer, the difference in income tax between inheriting a £100,000 pension pot from someone who died the day before they turned 75 and someone who died the day after turning age 75 would be £20,000. For a higher-rate taxpayer receiving a £1,000,000 pension pot, this difference in income tax would rise to £400,000.