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Chancellor Rachel Reeves has been urged to consider alternatives to inheritance tax (IHT) on pensions.
Plans announced in the Budget are currently under consultation but are not due to come into effect until April 2027, creating time to explore other options for reform.
The proposals mean any unspent pension assets on death will be treated as part of the individual’s estate and may be subject to IHT. Once passed to the beneficiary, income withdrawn from the pension can then also be subject to income tax at their own marginal rate.
Investment firm AJ Bell said the double taxation proposed means pension assets will be subject to a 64% effective tax rate on death where the pension pot exceeds the IHT nil-rate band, and the beneficiary is a higher-rate taxpayer. In many cases, it said, it will be far higher.
In addition, the firm said the proposals are likely to cause significant delays distributing money to families on death and in some cases may prove unworkable.
According to AJ Bell, pension schemes will be required to engage with the personal representative (PR) of the deceased scheme member.
PRs will need to identify all pensions that were held in the individual’s name and determine how much of their IHT nil-rate band should be apportioned to the scheme or schemes.
This will cause inevitable delays, particularly where no will exists, and in many cases PRs will not be able to complete the process within the required six-month window, AJ Bell said.
AJ Bell has suggested two options it believes would be simpler and fairer while still reforming the treatment of pensions on death.
One is to use a system similar to the current treatment of ISAs on death. It said this provides a pre-existing template for the reform of pension taxation on death and would mean investments are treated equally as part of the estate.
The other suggestion is to rely on income tax at the beneficiaries’ marginal rate.
AJ Bell said this offers a fair system in which those inheriting pensions with the highest incomes pay more tax, while also offering simplicity given pension assets are already subject to income tax where the member dies after age 75.
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