Rachel Reeves at the World Economic Forum (Image: Getty)
Baroness Ros Altmann has slammed Labour’s decision to put “draconian” inheritance tax on pensions as "disastrous".
The former pensions minister warned Rachel Reeves’s proposals will cause administrative chaos, huge delays for bereaved families, extra costs for all pension providers and long-term damage to future defined contribution pensions.
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She said: “Government proposals to tax your pension fund, if you haven’t taken all the money out before you die, are disastrous.
“These proposals for imposing IHT on inherited pension funds will cause administrative chaos, huge delays for bereaved families, extra costs for all pension providers and long-term damage to future DC pensions, as people are incentivised to take the money out as quickly as possible to avoid the draconian death taxes.”
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The Chancellor announced at the Budget that from 6 April 2027, unused pension savings may be included in estates for IHT purposes.
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Currently, if a pension holder dies before the age of 75, their beneficiaries can typically inherit the remaining funds tax-free, whether as a lump sum or as income.
After age 75, the inherited pension is taxed at the beneficiary’s marginal income tax rate.
These funds are currently outside the scope of IHT.
But financial experts have warned the proposed changes could result in a double whammy of both inheritance tax and income tax on inherited pensions, meaning higher-rate taxpayers facing a marginal rate of tax of at least 64%.
Rachel Vahey, AJ Bell's head of public policy, said: “Rather than pressing ahead with what is clearly a flawed plan, the Treasury must consider pragmatic alternatives such as applying income tax on death or simply following the template currently in place to apply inheritance tax to ISAs on death.
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“There is still time for ministers to see sense and deliver a workable solution by April 2027, but first they will need to acknowledge the clear problems that the current proposals will create.
Baroness Altmann proposed an alternative – a simple flat-rate 20% levy on all unused pension funds on death regardless of age– which would avoid the “damaging side-effects” of the current plans.
She said: “The remaining fund can pass as a pension to the next generation or other loved ones and will only be taxable on withdrawal but can remain invested tax-free until that time.
“This could start pension funds passing down generations too, as we know that most younger people have much less pension wealth than ideal.
Ms Reeves last week faced renewed calls to scrap “Britain’s most hated tax” after the country’s inheritance tax receipts ballooned.
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IHT bills totalled ￡6.3 billion in the nine months to December - ￡600million higher than the same period the previous year.
Around 4% of deaths result in an IHT charge but this could rise to 10% by 2030.
The Department for Work and Pensions has been contacted for comment.