Understanding government proposals for tax on pensions
Posted on 25th September 2023
There are plans to revise the pension and inheritance tax system. HM Revenue & Customs (HMRC) is also proposing changes to exemptions for people who inherit pensions. You and your benficiaries could lose more funds from your back pocket.
Pension Lifetime Allowance
Many of us have built up a pension pot over the years without realising there’s a limit to how much you can save.
Until April 2023 the Lifetime Allowance was £1,073,100. If you went over this limit you would pay 55% tax on any lump sum payment and 25% on any other pension payments or cash withdrawals. However, in April this year the Allowance charges were abolished. At the moment you can withdraw a quarter of your pension pot tax free. You’ll pay marginal income tax at 20%, 40% or 45% on any other withdrawals.
However, things are likely to change.
The Treasury has just published its plans affecting pensions to come in to effect from April 2024. These limit the maximum tax free lump sum you can withdraw and death benefits. The maximum lump sum withdrawal allowed is £268,275 in your lifetime unless you have protection arrangements. There’s also a ‘Lump Sum and Death Benefit Allowance’ of £1,073,100. This is the tax-free lump sum you take while you’re alive and lump sums paid at your death.
Pension changes affecting beneficiaries
Currently, if you die before you’re 75, your loved ones can inherit your unused pension. This is tax-free if taken as income, provided the pension is below the Lifetime Allowance.
If you are over 75 when you die your beneficiaries might have to pay income tax. Withdrawals are added to their total income from all sources, and taxed at their marginal rate, according to their total income.
However, because inheritance tax (IHT) doesn’t apply, pensions have been an attractive way to save for the future.
HMRC now plans to charge income tax on all inherited pensions from April 2024.
If the proposals go ahead, there are two choices for your beneficiaries. They could receive a tax-free lump sum up to the Lifetime Allowance limit or inherit the pension in their own name. If they choose a tax-free lump sum any unspent funds could be subject to inheritance tax at 40% when they die. If they choose to inherit the pension, income tax will apply to their future withdrawals.
If your beneficiaries are basic rate tax payers taking income would mean paying 20% tax. If they pay 40% or 45% income tax a lump sum could be a better choice.
What if you have already inherited a pension pot from someone under 75? Currently, it’s not clear whether you will have to start paying tax on the income next year.
Confused? We all are.
Please get in touch if you have any questions about pensions and estate planning.
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