Chancellor Rachel Reeves is facing calls to tax (Image: Getty)
Rachel Reeves is facing growing calls to introduce an inheritance tax raid on pension pots to help pay for spending pledges.
Economists are urging the new Labour Chancellor to introduce a death tax on unspent defined contribution (DC) pension funds.
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Defined contribution pensions are not currently subject to inheritance tax.
But Ms Reeves is under pressure to tax pension pots the same as other assets when someone dies.
Rachel Reeves is looking for cash to fund spending commitments (Image: Getty)
Bill Dodwell, the former head of the Office for Tax Simplification, said: “There has never been a good reason why pensions inherited from someone who died before age 75 should not be liable to income tax. After all, the original pension holder received tax relief on pension contributions.”
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The standard inheritance tax rate is 40%.
David Sturrock, an economist at the IFS, said: “The current system gives an incentive to hold onto pension wealth and use other assets to fund retirement.
“This leads to the rather perverse situation where pensions are used as a vehicle for inheritances rather than to fund retirement.
“In terms of the inheritance tax revenues that would be gained from bringing pension pots into inheritance tax, the impacts now would be modest.
“We estimate around ￡200m extra could be raised now. But the importance of this special treatment is set to grow quickly because more and more people will arrive at retirement with wealth in DC pension pots over time and the sums involved will be larger.
“In the coming decade or so, we estimate that the revenues raised by bringing pension pots into the scope of IHT would be in the range of ￡1bn to ￡2bn.”
Former Pensions Minister Sir Steve Webb added: "Any review of pension tax relief is likely to look at the favourable tax treatment of pensions when someone dies.
"The Government may look at ending the way in which wealth held in Isas counts as part of an estate but pensions do not. This might be especially attractive with more people saving into ‘pot of money’ pensions, meaning the tax loss from excluding them from IHT is likely to increase.”
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Adam Smith, the former chief of staff to Mr Hunt, said Treasury officials had recommended the move in the past.
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He said: “Removing the relief available on agricultural land and businesses plus including pensions within someone’s taxable estate would raise ￡1bn-￡2bn a year and was an option we looked at to raise revenue and as a way to fund a cut in the headline rate of IHT. Labour obviously won’t do the latter but may need the former.”
A new report from the think tank Demos said Britain is “unusual” globally in allowing pension wealth to be passed on tax-free and should consider removing or limiting the relief as the savings pots have become a means of passing on wealth, rather than exclusively saving to cover living costs in old age.
Demos said: “Taxing inherited pension wealth makes economic sense – because pensions are currently treated more favourably by the tax system if given as bequests than if used for retirement income, which is what they are meant for.”
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