Pension schemes have been subject to political rethinking and swings in levels of benefit to the saver ever since there have been pension schemes. We may now be on the brink of further and fundamental change.
Up until the 1970s, pension provision was modest with some companies providing final salary schemes, albeit without the immense protections that became so onerous that many companies abandoned such schemes. Incredibly, business owners of a limited company could not benefit from a company pension structure but were treated as self-employed with limited pension options. For those with defined contribution schemes, retirement annuities and personal pensions, at retirement, pensions were invariably bought out on the annuity market in days when interest rates and long-term bond yields were consistently high.
Then, as the UK experienced a painful metamorphosis from a manufacturing-led economy to a service-led economy, business owners (controlling directors) were allowed to establish their own company pensions. This resulted in enormously high contributions and an explosion of director pension plans throughout the 1980s. Contribution limits were substantially increased for retirement annuities and, towards the end of the decade, the personal pension plan was introduced offering millions the opportunity to invest in their own pension plans.
Over the last two generations since 1960, the UK population has increased by nearly 30% to almost 70 million. A consequence of this history is that the amount of money held in pension schemes has grown dramatically and is now estimated to account for approximately 40% of all wealth in the UK – some £7.1 trillion.
For individuals whose total wealth is in excess of £500,000, approximately more than a quarter is now held in their pension plans. Even over the last 15 years or so, the amount of money held in pension pots at all age groups over 45 has more than doubled. At the same time, ten years ago, over 350,000 annuities were purchased but by 2021 this had fallen to just over 60,000. Assuming this general trend continues, there will be a substantial increase in the number of individuals dying with pension pots they can bequeath.
The Institute for Fiscal Studies (IFS) notes that a married couple who both had pension pots equal to the current Lifetime Allowance could bequeath more than £3,000,000 without incurring any inheritance tax (IHT) simply by leaving their funds in their pensions and making full use of their inheritance tax thresholds.
In providing enormous tax benefits to approved pension schemes, the Government hoped to encourage people to save for their retirement to avoid having to revert to the state for financial support in their retirement. The reality is that the ‘man in the street’ has by and large turned his back on pension provision, but high-net-worth individuals have embraced it to take full advantage. Very crudely, the value of tax reliefs and exemptions will have contributed approximately half of all pension funds, and it therefore seems quite logical there could be a form of recovery tax applied to pension funds.
There is a precedence for this: under New Labour, Gordon Brown introduced a 70% tax charge on pensions at death, arguing that this broadly equated to the tax relief on contributions and tax exemption on pension investments. It got worse, as the residue of 30% was then treated as an asset of the estate and liable to inheritance tax. Accordingly, the total tax take was as high as 82%. When the Coalition was elected in 2010, the tax charge was reduced to 55% and has subsequently been abolished in 2023/24 on funds within the client’s LTA.
It therefore comes as no surprise as the benefits of investment into pensions are so strong – especially with the Lifetime Allowance being removed and pension contribution allowances increased – that the IFS in recognition of these trends has formally proposed that the Government considers reimposing tax on pension funds at death. While still only at consultation stage, the symmetry of a pendulum swing may suggest any alteration in this direction is likely to be considerable.
All content correct at time of writing.