AJ Bell calls on Chancellor to consider alternatives to IHT on pensions

AJ Bell has today called on Chancellor Rachel Reeves to consider alternatives to inheritance tax (IHT) on pensions announced in the recent budget

In a letter to the chancellor and her Treasury department AJ Bell has outlined flaws in proposals to subject unspent pension assets to IHT on death. Plans announced at the Budget are currently under consultation but are not due to come into effect until April 2027, creating time to explore other options for reform.

AJ Bell is calling on government to consider alternative options, which the group says would be simpler and fairer while still reforming the treatment of pensions on death.

The business has proposed either using a system similar to the current treatment of ISAs on death, or simply relying on income tax at the beneficiaries’ marginal rate, both of which represent preferable alternatives to the government proposals under consultation.

AJ Bell CEO, Michael Summersgill, says:

 
 

“The proposals set out by government create huge complexity and will delay families from accessing money in a timely fashion following a bereavement. In some cases the proposals will be unworkable and will create financial gridlock in the probate process, especially where assets held in the pension can’t be sold quickly.

“Add to this the fact that the proposals could result in millions of people paying a minimum tax rate of 64% on inherited pensions, and there is a real risk that confidence in pensions will be seriously eroded.

“We’re urging the chancellor to instead consider alternative proposals from the industry, which would be fairer and simpler, without undermining her plan to tax unused pensions on death.”

Government proposals

 
 

Government is currently consulting on proposals to introduce an IHT liability on unused pension assets on death from April 2027.

The proposals mean any unspent pension assets on death will be treated as part of the individual’s estate and may be subject to IHT.

Once passed to the beneficiary, income withdrawn from the pension can then also be subject to income tax at their own marginal rate.

The double taxation proposed means that pension assets will be subject to a 64% effective tax rate on death where the pension pot exceeds the IHT nil rate band and the beneficiary is a higher rate taxpayer. In many cases it will be far higher.

 
 

In addition to the potential for punitive levels of taxation, the proposals under consultation are likely to cause significant delays distributing money to families on death and in some cases may prove unworkable.

Pension schemes will be required to engage with the personal representative (PR) of the deceased scheme member. PRs will need to identify all pensions that were held in the individual’s name and determine how much of their IHT nil-rate band should be apportioned to the scheme or schemes. This will cause inevitable delays, particularly where no will exists, and in many cases PRs will not be able to complete the process within the required six month window.

Liquidity also presents a major challenge under the current proposals.  Pension funds holding illiquid assets – something the government and the FCA are specifically trying to encourage through the creation of Long Term Asset Funds (LTAFs) and wider policy initiatives – will often struggle to sell these within a year, let alone six months.

Alternative proposals

AJ Bell is instead calling on the chancellor to explore alternative measures put forward by the industry as part of the consultation process.

The business has suggested two options, which it believes would be simpler and fairer:

  • ISAs are already subject to IHT on death. This provides a pre-existing template for the reform of pension taxation on death and would mean investments are treated equally as part of the estate.
  • Income tax applied on withdrawals at the marginal rate of the beneficiary represents another simpler alternative. This offers a fair system in which those inheriting pensions with the highest incomes pay more tax, while also offering simplicity given pension assets are already subject to income tax where the member dies after age 75.

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