Generosity of current rules
Under current rules, your pension can pass to your
beneficiaries free of UK Inheritance Tax (IHT), rather than being subject to
the standard 40% rate. Additionally, if you die before age 75, your
beneficiaries do not need to pay any tax on drawdown/lump sums. If you die
after 75, and your beneficiaries are UK tax resident, they are subject to
income tax at their marginal rate.
This is what makes pensions so valuable for tax
planning and advisers will usually recommend that they are maximised and
preserved, and that other assets subject to IHT are used to fund spending
first, to reduce the value of your estate.
What could change?
The IFS pointed out that the current tax rules on UK
pensions are very generous and pensions have become a succession planning tool
rather than one for retirement provision.
Experts are musing that the UK government could change
these generous IHT rules; many say this is overdue. More worryingly, they are
anticipating a potential change in 2023.
The IFS recommended that a basic 20% rate is applied
to any pension savings left on death, irrespective of age. Also, the pension
should form part of the deceased’s estate for IHT, incurring a further 40% tax.
Why the change?
Simply put, changing the pension IHT rules would fill
a big hole in the Exchequer’s coffers by bringing millions of pensions into the
IHT net. It would also persuade many people to start spending their pension
pots and in turn, pay income tax on the drawdown during their lifetimes.
The report explained how the generous UK pension rules
specifically in relation to IHT have caused a “bizarre situation” where instead
of pensions primarily being an attractive structure for old-age-planning, they
have become a lucrative IHT loophole. The IFS also pointed out, “if we are to
have an inheritance tax at all, it should apply evenly across all forms of
wealth.”
We have also seen pensions being periodically targeted
over the past decades, with taxation and limits applied in the form of Annual
Allowance, Money Purchase Annual Allowance and the continuing reduction of the
Lifetime Allowance, from £1.8.m in 2011/2012 to £1,073,100 in the tax year
2022/2023 - all with the aim of curbing the tax benefits. There are even
serious talks of bringing the increase in the UK State Pension age forward from
2046 to 2035.
Will this affect you?
Those with estates valued in excess of £325,000 (if
single) or £650,000 (jointly), including pension values, would be affected by
any potential change.
It is unclear how any potential change would be
introduced, although the IFS has suggested phasing in changes. It is also
unclear if existing benefits would be sheltered from the change or if the rules
would be retrospective, thus catching all pension savers. Although, the IFS did
say that even with phasing, there would be some retrospective taxation effect.
What should you do?
Of
course, there is no guarantee this will happen, but if changes are imposed
there may be little or no opportunity to restructure your pensions. As a non-UK
resident, you can take action now and review your finances to ensure you are
protected.
Debrah Broadfield and Mark Quinn are Chartered Financial Planners (level
6 CII) and Tax Advisers (ATT) with nearly 20 years of combined experience
advising expatriates in Portugal on cross-border tax and financial issues. For
a complimentary initial chat contact us at: +351 289 355 316 or mark.quinn@spectrum-ifa.com. Find
out more at www.spectrum-ifa.com