My advice to the Treasury is simple “make DC pension pots taxable as part of the inheritable estate”.  It’s a tax break we can do without 

The situation at present is like this

1. Take your money out of your pot and put it in the bank – that money is now liable to inheritance tax (IT) if you die
2. Keep your money in your pot and not spend it – 100% of the pot is outside the estate till you reach 75, after that payments from/of the pot are paid after the provider has deducted tax at your highest rate,
3. Buy an annuity, the money dies with you – unless there is a guarantee if you die early when the amount is repaid to the estate and taxable.

(The full rules are laid out by the Government – available using this link)

This makes  money retained in a personal pension , tax-advantaged in the event of death. Though most people who make it to 55 , make it to 75, people feel incentivised to use their pension as a means to protect their inheritors from death taxes.

Surely this is contrary to the purpose of granting tax-relief on pension saving? The reason we save for retirement is to replace income that formerly came from work. Money not spent is outside the economy and typically inactive. The Treasury should want pension savings spent and for any drawdowns or income to be taxable. That is the EET deal – exempt on contributions, exempt on investment growth and taxed on delivery in retirement.

So why is there this inheritance tax exemption? I’m told that it relates to the trustee’s discretion as to to whom the money is paid. Occupational pensions tend to operate under a discretionary trust and so lump sums are treated as tax-free to the beneficiary of a death-claim. There have been anomalies

Until recently, there was no discretionary trust available at Nest but recently Nest has introduced a nomination of beneficiaries death benefits form. Fill this in and  Nest will then decide whether or not to pay their pension pot to the beneficiaries listed on the form – taking changes to the members’ personal circumstances into consideration. If Nest decides not to pay to those beneficiaries, the pot will usually be paid to the member’s estate but the discretionary trust is enough to prevent the money being liable to IHT.

Reform needed?

In a recent seminar with LCP, Paul (the God) Johnson suggested that the exemption that is given to personal pensions ,which is not dependent on a discretionary trust, but means that if the policyholder dies before 75 his/her’s estate is not liable to IHT is crazy.

I agree. It incentivised people not to drawdown money, precisely the opposite to what the policy intent would be. In Australia there is a Retirement Income lobby in place whose job it is to make sure that the money in DC is spent before death and not left to the estate.

I do not know how much tax is foregone as a result of people dying with personal pension pots before they get to 75 but it must be substantial as the wealth management industry cite the anomaly as the best reason for not buying an annuity. Of course the real reason for investing with an IFA is to manage liabilities from a flexible pot but it does seem to me that IHT mitigation is not high on the Treasury’s wish-list , nor the preservation of wealth under advice.

So , if the Chancellor announced in the Autumn Statement that he will be abolishing IHT exemptions for money purchase pension pots, I will not weep buckets. Instead I will consider purchasing an annuity and redouble by campaigning to be able to buy a pension payable along CDC lines.