The Conservative Party has been heartened to hear that the Chancellor is responding to the attacks from UKIP with a straightforward appeal to the grey vote. He will announce to the party conference today that he is changing the tax rules that apply to income drawdown pots post the death of the pensioner; the so-called death tax that applies to the family who cash in the pension fund. From now on, this will only be taxed at the marginal rate, if the pensioner is over 75 when he dies and will not be taxed at all if the pensioner dies before that age.
This is definitely a crowd-pleaser for the grey vote; the very people that are currently being lured away from the Conservatives by UKIP. But while it may be a clever tactical move to win the general election, it distorts the situation around inheritance tax.
Next stage in pension reforms is abolishing death tax on pensions so people who've worked hard & saved can pass their pension on tax free
— George Osborne (@George_Osborne) September 29, 2014
When the idea of tax allowances for pension contributions was originally decided upon, it was based on the idea that it was a good investment for the taxpayer, as those who saved for their own pension would be far less likely to be a drain on the state coffers in their old age. Hence the quid pro quo for the tax relief was the compulsory purchase of an annuity, or latterly a controlled drawdown, ensuring that the pensioner would have an income for life and therefore would be in a better position to provide for their needs in retirement without additional support from the state.
This was fine for annuities but in the case of Income Drawdown products, there was likely to be a fund left upon death. To avoid this being used as a means of avoiding inheritance tax, a heavy rate of taxation (55%) was applied to the remaining fund upon death. Thus the system was designed to prevent the taxpayers’ largesse being abused by the more wealthy sectors of society.
The pension reforms announced earlier this year in the budget undermined this compact by breaking the link being tax-relieved savings and the provision of an income for life by abolishing the compulsory annuity purchase factor. It was expected that the punitive rate of 55% would be dropped to the inheritance tax rate of 40% in the next budget. However, with the Chancellor’s announcement today, it seems that the link is being broken even further. Tax-favoured savings in the form of pensions appear to make it possible to avoid significant inheritance tax if you are in the sector that has the money to put away, yet this seems completely unfair to those whose wealth is outside the pension environment and therefore will be unable to pass it on in the same way.
We await the detail but, like constitutional change, pension policy is now being designed tactically in response to political events rather than strategically, as such a long-term policy deserves. Pensioners and taxpayers deserve a better planned approach than this.
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