Rachel Reeves’ plan to tax pensions has come under sharp attack from experts, who have labeled it “unworkable” and full of problems. The Chancellor of the Exchequer’s proposal would impose Inheritance Tax (IHT) on unused pension funds and death benefits, including those from final salary schemes, which have traditionally been free from such taxation.
Reeves’ policy, to be introduced through her first Budget, will impose IHT on pension pots inherited by beneficiaries from April 6, 2027. This is part of a consultation with pension providers and consultants. Currently, funds in pensions, particularly in final salary schemes, can be passed down without the need for inheritance tax. The practice has been long-standing, but the new rule will change that. Experts fear the new policy would bring too much complexity and implications for reform.
Inheritance Tax is paid at 40% for estates above £325,000, though there are some exceptions, including the residence nil-rate band, where parents or grandparents can leave up to £175,000 worth of property to children or grandchildren tax-free. The plan from Reeves to tax IHT on pensions will affect unused pension funds as well as death benefits paid out.
Experts claim that this will only make the already complicated tax regime of the state more complex and involve unnecessary complications. Kate Smith, head of pensions at Aegon said, “We do not agree with unused pension and death benefits being made to fit the Inheritance Tax regime as it is unworkable and full of problems. IHT is already complex, and involving pensions adds to the same.”
The British pension system is said to be amongst the most intricate, comprising all sorts of different occupational and personal pensions. Change in taxation concerning this system can only be a sensitive affair, according to experts. Indeed, many people, especially survivors, have often relied on final salary scheme pensions as important family assets providing a safety net. Applying IHT to the funds has elicited fears for families inheriting such assets.
The concerns don’t stop at the complexity of the system; experts also fear that introducing a new tax on pensions could increase the already overwhelming burden on the probate system. Probate, the legal process of administering the estate of a deceased person, has seen long delays in recent years due to increasing demand. The proposed changes would only worsen these delays, making the whole process even more complicated for families who have already lost a loved one.
Pension schemes, particularly those with big final salary benefits, can sometimes be worth more than the £325,000 threshold that brings IHT. The new tax would create a situation where the surviving family members might face severe tax bills on pensions they had not factored in. It may lead to significant financial pressure for families, especially since they may have to sell properties or liquidate their assets to settle the tax bill.
The Chancellor’s plan may disproportionately affect certain sectors, such as public service workers. For instance, firemen who die in the line of duty could find that their pensions, which were previously considered a secure benefit, are now subject to IHT. The change is particularly worrying for those who have worked for decades to build up pension pots, only for their loved ones to face a significant tax burden upon their death.
While the government defended the move as a necessity for leveling the playing field and increasing tax revenue, the reaction has been fierce. The plans announced by Labour have already attracted widespread criticism from several quarters with demands for retraction of the changes. Many experts argue that the government should take a more cautious approach, as further complications could make an already difficult financial landscape even more challenging for ordinary Britons.
This has been talked about for some years now as an extension of IHT, but rarely gets much traction from the pension industry. Proponents of change argue that changes could have some unintended effects in terms of retirement savings, which is where this could lead in terms of pension fund being taxable. This might not encourage people to save into pensions in the first place and might undermine long-term retirement planning for the majority of the population.
The long battle in this debate has led to the arising question on pensions and inheritance tax. The government will have to rethink its strategy to reduce the high costs of public services and welfare as it settles on finding an equilibrium between state needs and familial security. For many, though, the current proposal will only lead to uncertainty and increased complexity, probably harming the very people it should assist.
Although the consultation will run through to 2025, there are still many who believe that the government should reconsider its proposal. After all, the response to the announcement has been significant in its opposition. Whether Rachel Reeves will stay with her idea or whether industry experts and public pressure will see her change her mind on how this will affect pensions and inheritance planning in the UK remains to be seen.