Countries worldwide are battling the financial consequences of Covid and the cost of living crisis. The UK is no different, with government resources struggling to provide services to the public. Into the fray stepped the Institute for Fiscal Studies (IFS), a leading independent economic research institute, with proposals for personal pensions and IHT (inheritance tax).
Their job is to analyse the economic situation at any given time and produce reports, outlining their opinion on what measures governments should take to combat headwinds or take best advantage of calmer waters.
The IFS have published a controversial report on personal pensions and IHT, aimed at raising money from Defined Contribution (DC) pension funds. Approximately £7 trillion is currently held in private pension schemes. No wonder the IFS considers this a source of ‘low-hanging fruit’.
They argue that increasing taxation on DC pensions is a matter of fairness and will redistribute wealth from the well-off to those who are just about managing. It’s worth noting that the ‘just about managing’ here is the government itself!
Personal pensions and IHT exemptions
The IFS proposes removing the Inheritance Tax exemption on private pensions and extending income tax liabilities on beneficiaries. Personal pensions fall outside IHT rules when winding up an estate of someone deceased. Assets can be passed on to the next generation free of IHT and income tax if the pension holder dies before age 75. Subsequently, taxation falls on the beneficiaries under income tax rules, and is particularly heavy if lump sums are taken.
One of the reasons for proposing a change is that pensions are often used to pass wealth down through generations tax-efficiently. By contrast, the IFS argue they should be used to provide the majority of an individual’s retirement income. As such, pension pots should be gradually depleted, with little left on death. So, for those who withdraw small amounts to benefit from favourable IHT treatment, this would be bad news as their IHT-liable assets would be increased and exposed to tax.
The IFS is also proposing to scrap the pre-age 75 income tax exemption. This means beneficiaries would be liable for income tax irrespective of the age at which the pension holder’s death occurs.
Expat pension planning
Whilst this may be seen as bad news for UK pension holders, particularly those with large pots, it doesn’t have to be damaging for expats.
Many have relatively large UK personal pensions, which may be liable for the Lifetime Allowance (LTA) charge. There are ways to delay this charge by, for example, going into drawdown before the fund reaches the LTA limit or applying for Fixed or Individual Protection.
Transferring to a Malta QROPS
It should be noted that Dual Tax Treaties (DTTs) don’t always help expats. For example, the DTT between the UK and Spain doesn’t cover Inheritance Tax or the LTA. This means tax could be paid directly to HMRC in the UK, then again to the Hacienda in the case of non-direct family members who are beneficiaries.
If the UK government adopts the IFS proposals, it won’t be possible for even expats to avoid the issues surrounding personal pensions and IHT. There is a solution, however.
Transferring to a QROPS releases the expat pension holder from the LTA charge permanently, and in many cases, they will also be able to avoid the new tax. It’s important to consider individual circumstances, as not everyone’s family situation will be the same. However, the case for transferring UK pensions into a QROPS will be much stronger if these measures become law.
As there is no Inheritance Tax levied on Malta pensions and benefits can be paid to inheritors almost instantly, control of taxation will be in the pension holder’s hands. Depending on other factors, there may still be tax consequences in the country of residence, but tax won’t be payable in two territories.
Whilst it’s important to remember that this proposal carries no weight with either the Pensions Regulator or the UK government, it may prove to be too tempting to ignore by the Chancellor in the next budget!
If you’d like to know more about how the IFS proposals on personal pensions and IHT may affect you, please complete the form below: