Fears that 'stealth' inheritance tax raids could hit bereaved

Fears of a second hit to the bereaved linked to inheritance tax have been sparked by small print hidden in the budget. The Chancellor has revealed a plan to scrap an inheritance tax exemption for pension pots passed on if an individual dies before reaching 75, which could cost mourning families hundreds of thousands of pounds.

According to some estimates, those inheriting a pension pot could lose up to 67 percent of it due to a mix of the death tax and income tax. However, there are worries that Rachel Reeves is also considering another way to seize cash following a death, involving death in service payments.

These payments, potentially as much as four times annual salary, are typically a lump sum given to named beneficiaries of an employee who passes away while still employed. Often managed as part of a pension scheme, these payouts – which can be as high as four times the worker’s yearly wage – might be targeted by Labour ’s tax raid on pensions.

Following the budget, financial experts suggest there's a chance the government will take a portion of the payment, depending on how it's administered. Some schemes make death in service payments from a group life insurance policy held in trusts, and therefore not subject to inheritance tax on that basis.

Certain schemes, including for the police, will see death in service payments subject to tax as a pension lump sum, potentially meaning bereaved families could forfeit up to 40 percent of these funds. Furthermore, beneficiaries might pay taxes based on their income rates on any of the money received.

The Police Federation of England and Wales has acknowledged the impending changes and is assessing potential impacts on pension schemes. Ex-pensions minister Ros Altmann commented to the Telegraph: "It will obviously have some knock-on unintended consequences on people who die unexpectedly soon on a company scheme which for many of our public servants of course they should have good pensions."

She added: "If they are told suddenly their death in service benefit is worth 40 percent less than they would have ever dreamed, then those in particularly dangerous public service may think twice about carrying on with their jobs."

Unison informs that local government death in service payments will also be liable for inheritance tax from 2027, and the union is actively seeking details regarding how these alterations will influence death in service benefits.

Treasury papers have identified the death benefits subject to inheritance tax, encompassing defined benefits, lump sum death benefit, drawdown funds from which beneficiaries can withdraw lump sums, and annuity-related lump sums distributed to beneficiaries following a person's death. The Government has kicked off a three-month consultation period to refine the implementation of this change, which has prompted experts to caution that it could result in a "bureaucratic nightmare" to manage.

Current propositions indicate that grieving families may have to locate all pension plans of the deceased, liaise with each scheme separately, and figure out the inheritance tax due on their own.