Potential changes to the taxation of inherited pensions

Current rules

If you inherit a pension from a person who died before reaching the age of 75, in the vast majority cases the funds can be withdrawn as a lump sum without any tax. 

The position changes if you inherit a pension from a person who died after reaching the age of 75, in which case you would normally be subject to Income Tax at your marginal rate (20%/40%/45% depending on your total taxable income) on withdrawals from the fund.

Proposed changes from 6 April 2024

The policy paper states that where a pension is inherited from a person who dies under the age of 75, to the extent a lump sum withdrawal is made above the deceased member’s lump sum tax free limit (currently £268,275), the excess will be subject to Income Tax at your marginal rate. This could clearly lead to a much greater tax liability if you inherit a pension from somebody aged under 75, after 6 April 2024.  

The changes would bring the rules broadly in line for the current rules for those who inherit pensions from a member who was aged over 75 at the time of their death, but it appears they would allow for the use of the deceased person’s unused lump sum allowance of up to £268,275.

The policy paper is an overview of the objectives and so is not draft legislation (which is not yet available) and so it remains to be seen how the rules will be implemented and whether any transitional/grandfathering rules are put into place, for instance to exclude pensions inherited prior to 6 April 2024 from the new tax charge. It would appear particularly unfortunate timing for those who inherit pensions very shortly prior to 6 April 2024 but do not have time to withdraw the funds prior to the implementation of the new rules. 

What should you do?

In view of the proposed changes, now is a good time to start considering the potential implications for any pensions you have inherited and whether you should look to take action prior to 6 April 2024, when the new rules are proposed to be implemented. Time may be of the essence in order to optimise your position. 

If you think you could be impacted by the proposed changes, or if you have any other queries about financial or tax planning, fill out the form below and one of our experts will be in touch to help. As experienced financial planners and personal tax advisers, we can provide advice and guidance tailored to your specific circumstances.