Tax on tax? No thanks! Is it time to spend spend spend…?

Written by Rory Dorman, ACA

I nearly fell of my chair when Chancellor Rachel Reeves announced that UK pensions would fall within the scope of inheritance tax during her greatly anticipated Autumn Statement. Initially it read as though it would only be pensions that had previously been inherited that would fall into scope, which I thought seemed fair enough: if a pension pot had swollen to such dizzy proportions that it was capable of feeding TWO generations below, then fair game. But no, it soon became apparent that every UK (Defined Contribution) pension left in a person’s estate would first be subject to 40% inheritance tax, only to be followed in short order by a second round of income tax on drawdowns, more often than not at 40% again. That is tax on tax, and it works out to be pretty painful: 40% on 40% computes to an effective tax rate of a whopping 64%! I recognise that this is already how it works the other side of the pond, but the US lifetime allowance at a little over $13m is a smidgen more generous than the paltry £325k equivalent in the UK, so I’ll let Uncle Sam off on that one. The point of the story is that there will be a lot of UK estates with pension assets caught out by this raid.

So, what’s the answer?  Well, at the most basic level, is it time for those octogenarians to let down what hair they may have left, dust off their party frocks, and (you guessed it!!) spend, spend, spend…??!!  But that is probably not what they had in mind when they were faithfully squirreling savings away into their pensions, hoping any excess might feather the nest for future generations. Of course, I understand the rationale, if pensions are going to be double-taxed, what’s the point of saving into them? You might as well spend instead alongside those in their twilight years…!!  And given the multiplier effect on spending, this would surely unbridle the UK’s anaemic growth, and perhaps it will to a degree. But I wonder at what cost, and at what eventual burden on the state, when younger generations reach old age with pension pots that leave them barely scraping by. What then?

The obvious alternative to a caviar and champagne habit in old age is to aggressively drawdown the pension assets ahead of time, and gift the proceeds down to the next generation outside the scope of UK inheritance tax, provided the donor survives 7 years from making the gift. However, this requires quite delicate planning. Hold back enough cash in the pension to see you through 7 years, but anything in excess becomes subject to a 64% tax (ouch!). On the other hand, anything less might leave you strapped for cash. What a relief you have access to such a talented team of financial planners to help you.

The Legal Stuff

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