by Neil Lovatt
Under new government proposals published last week, it will now be possible for the super rich to use their pension assets to avoid inheritance tax. The requirement for pension assets to be paid out within a person’s lifetime is removed in the new arrangements. But pension assets sit outside the IHT regime. Thus by leaving substantial assets in their pensions at death, the very wealthy will henceforth be able to avoid enormous amounts of inheritance tax.
The full set of the government’s proposed pension changes is here, and they are unlikely to be read by anyone other than the odd policy wonk, such as myself, or a specialist journalist with a readership of a few hundred. It’s hardly front page news, but it should be.
The problem with pensions is their inflexibility. The tabloid media waste no time in stoking the flames of hate over pension rules restricting access to your money.
Unfortunately, such claims use a sleight of hand that only policy wonks would see at first glance. Pensions are not simply “your” money. They are a combination of public money and your own. Pensions work on the basis of matching contributions with tax relief. So put in £1 and you get £1.25 as a basic rate taxpayer or £1.66 for higher rate payers. But it would be wrong to call this a government handout, because the deal with pensions has always been that you get tax relief on the way in but it’s clawed back on the way out when your pension income is taxed.
There are clear inefficiencies and loopholes in this system, such as higher rate tax on the way in and basic rate tax on the way out. But, leaving them aside, the pension system works as long as those in retirement are encouraged (or forced) to use their pension assets as income of some description. And therein lies the need for restrictions.
Enter George Obsorne. Two years ago, with proposals to lift restrictions on compulsory annuitisation of pensions, or, in other words, the rules that mean you have to convert your pension pot to a lifetime income (which will be taxed) or face a new set of income restrictions (called Alternatively Secured Pensions) with hefty tax charges on death.
The result is the paper published this week. A lot of it is quite sensible and improves flexibility of access but crucially maintains tax charges on exit. For example, early access to your pension assets will cost you an eye watering 55% in tax charges. Eye watering until you realise that that charge largely negates the high rate tax relief you received on the way in. The proposals also do away with any restriction on forcing pensioners to buy a lifetime income. So now it is possible to put assets in your pension and to never actually take assets as income.
Why, you might ask, would anyone put money in a pension and not take it out? Well, under the new proposals, on death, pension assets are passed on with a 55% tax charge. Sounds reasonable enough; HMRC gives you money on the way in but if you don’t use it then HMRC takes its money back and leaves your dependents with what you put in.
But here’s the devil in the detail. Pension assets are set up in such a way that they sit outside the client’s estate for inheritance tax purposes. That means that any pension assets paid on death will not be subject to inheritance tax. This is one of the reasons for the last Labour government’s extra tax penalties on death after 75 or the desire to get the pension money into a form of income (where it would be subject to inheritance tax).
Under these proposals it will now be possible for the super rich to use their pension assets as an advanced form of inheritance tax avoidance. By leaving what will be substantial assets in their pensions the well-advised and wealthy will be able to avoid inheritance tax on considerable parts of their estate and incur a tax charge which will only be taking back tax relief that was never used.
Make no mistake, tax planners and product designers like me will, if these proposals go through, be using this as a substantial means of inheritance tax avoidance. This is nothing more than an inheritance tax cut in a different guise.
Whatever you think about inheritance tax, it is difficult to argue that this technical change passes the progressive test. Furthermore, in the coalition agreement (which seems to be bandied around like a document with some democratic legitimacy) changes to inheritance tax were shelved. So are the Liberal Democrats being hoodwinked by this change or have they signed up to back door IHT cuts which go against both their manifesto and the coalition agreement?
Tom Watson is right: the devil is truly in the detail. Imagine the outrage if the government had openly proposed an IHT cut in this environment. But that is exactly what they are doing. I suspect that they hoped no one would notice. Sorry to disappoint.
Neil Lovatt works in the financial industry and writes on tax and pensions policy.
Tags: IHT, inheritance tax, Neil Lovatt, pensions, tax avoidance
On a related but separate theme I believe that most private pensions are bit of a con anyway. I don’t believe that any Labour Government should support private pensions but should instead insist on a higher living wage. I now why governements try and raise the uptake of private pensions – to reduce the burden on the state when we retire. However I was shocked to discover that my pension provider (for my company pension) is forecasting that it is going to charge me a staggering £28,000 for a £1000 annuity. So when I retire at 68ish I will have to live until 96 to get my money back. So not only have they charged me a management fee of 1-2% for the duration of my working life, and used my fund as an investment pot they are going to rinse me at the end. It may be that this pension is a particularly bad one, however I see that unless your employer gives you a particularly handsome contribution, or you are particularly well-paid, it is unlikely that you will ever see a sizeable income from a private pension. I would rather, therefore, that my employer gave me an increased wage than pay contributions to a blood-sucking pension corporation. Unfortunately, it is not in their interest to pay me better, as they couldn’t deduct an increased wage from their tax bill.
While the discussion is on pensions why is it that MPs, Police officers and military personnel can draw their pensions before 65 (or so I am led to believe, I do apologise if I am misinformed). I know we are not meant to criticise our brave armed forces and emergency services but are they not capable of working between 50 and 65 like everybody else? Groundworkers and miners also have dangerous and backbreaking occupations but their industrial pensions are neither generous or available before 65.
Osbourne must think that everyone is as thick as the idiots up in Knutsford who vote for him (speak with qualification of being an ex knutsford constiuent !!!!!) To mask a fantastic give away to the supoer rich like this beggars belief till you remember its a tory stealth move again. Tories have always been thieves and always will be. Lets just hope that this decade will see them as a dying breed and let socially responsible people into power.
Are you sure about this arithmetic?
Say I amased £1m in a pot. The Govt don’t tax me on the way in, so I’ve now got £1.67m. My choices are now:
1) Draw it down, and pay 40% Income Tax on it. The tax holiday on the way in (£0.67m) is about the same as the tax payable on the way out.
2) Leave it there, and pay 55% tax as an exit charge. My benefit in the way in (£0.67m) is more than negated by my exit charge (55% of the £1.67m is £0.9m). I have LOST c.£0.25m
The 55% exit charge is MORE than IHT – why is that so attractive?
I think you ignore the elephant in the room.
IHT is, and always has been a middle class tax.
The poor do not have many assets, and so do not pay.
The rich use loopholes (there are lots of them), and so do not pay. I work for a family business, the legal owner of which is now senile, but probably worth £20-30M. His sons who now run the business have taken sufficient precautions that they will pay <1% tax when dad finally dies.
The middle class gets hammered. My grandparents (moderately well off, grandfather, now 85, is a former manager from ICI, but hardly the traditional "rich") will get clobbered big-time as they haven't enough cash to justify the tax dodges, but when the value of their house is taken into consideration (bought for a song in the early 80's, now probably worth £3/4 millionish) will get heavily taxed.
Rich men and their accountants will always find ways round tax rules – this is just a fact. The best solution is to cut IHT – this reduces the incentive for the rich to avoid paying, while reducing the burden on the "squeezed middle". It may well also increase the tax take – if the headline figure was 1%, I doubt my employers would bother mitigating action, as it is, do to that mitigating action, they pay under 1%…
Gary,
The numbers are correct, to simplify (as the article is long enough) I didn’t comment on the fact that 25% of the fund is taken as a tax free lump sum, so there is no tax charge there. When you take that alongside the 55% on the remaining 75% it all washes through. There is also the benefit of long term tax free growth which can be substantial over time, think of it as a massive super rich ISA allowance, and these would only add to the benefit.
So you can’t compare 55% against IHT rates because the 55% is only clawing back what the government has already given you, when that all washes away whatever is in the pension fund is now outside the IHT regime so the IHT rate is nil.
You are right of course that you could take the income and only pay 40% on it but surely it’s better (if you are super rich) to live off non off non pension income (which will form part of your IHT estate) and run down these assets rather than withdrawing from your pension which is non IHT free.
Believe me when I say we in the industry are already planning a number of strategies to maximised the IHT impact of this change for the super rich and if anything I have downplayed the numbers.
TheProle I don’t think we have ignored the elephant in the room. We can debate IHT all we want and I admit that there are both positives and negatives to the tax, the point of this article is that the Coalition have just announced a super rich IHT tax cut to no debate, scrutiny or challenge. Surely when times are so tight when a super rich tax cut is assignees it should be taken up in the floor of the House of Commons so we can as a political class debate the merits of it?