‘Budget change to Inheritance Tax on Pensions set to be ‘gold mine’ for government’ – Tim Camfield, LCP
Pensions & benefits Pensions tax DC pensions DB pensions
The government’s plan to include pensions in the Inheritance Tax (IHT) net is likely to yield tens of billions of pounds over the coming years, according to new analysis by LCP.
According to figures published on the day, the change (which is due to be implemented in April 2027) will raise £640m in the first year, followed by £1,340m in 2028/29 and £1,460m in 2029/30. However, estimates by LCP suggest that this figure will rise sharply through the 2030s and beyond, raising well over £3 billion per year at its peak. The total yield from the change could easily exceed £40 billion over the next two decades.
The reason why revenue from this measure is set to rise sharply relates to the surge in pension transfer activity in the 2010s.
Following the introduction of ‘pension freedoms’ in April 2015, there was a dramatic growth in the number of people exchanging their rights under traditional Defined Benefit pension schemes for a cash transfer into a Defined Contribution pension pot. Six-figure transfer values were the norm, and over 100,000 transfers were undertaken in the five years after pension freedoms. In some cases, these transfers were undertaken specifically so that there was a balance to be inherited when the member died. The peak in transfer activity was in 2017/18, after which tighter rules around financial advice were followed by a fall in transfer values, which led to a dramatic reduction in the volume of transfers.
The typical person who transferred was in their late fifties in the late 2010s. As these people gradually die over the coming years, any unspent balances in their transferred pension fund will be potentially liable to IHT under the proposals set out by the Chancellor in her October Budget.
LCP has undertaken estimates for the market as a whole based on a sample of schemes it administers and based on the range of life expectancy of the people who transferred. The modelling suggests that the tax taken purely on residual transferred DB funds could reach £3 billion per year, and on top of this, the government will benefit from IHT on regular DC pots (that is, pensions, which did not originate in a DB scheme). This suggests that the annual revenue from this change will rise far above initial estimates and will be enhanced for several decades because of the legacy of transferred DB funds.
Applying Inheritance Tax to pension balances could prove to be a real gold mine for the government for many years to come. The surge in DB pension transfer activity, which we witnessed in the late 2010s, will dramatically increase the number of people whose estate includes a significant DC pension balance. Some may react to the tax changes by drawing down on their pension assets faster, but that will still generate significant tax revenue; as such, withdrawals will be subject to income tax. Either way, as the DB transfer generation gets older, the government will start to see a multi-billion-pound revenue stream from the income tax or IHT on their pension pots.
Tim Camfield Senior Consultant, LCP
Notes to editors
- Estimates of the revenue from the change to the treatment of pensions for IHT purposes can be found in Chapter 5 of the Budget Red Book
- FCA data shows that just in the period from April 2015 to September 2018, over 170,000 people who sought advice on a DB transfer were recommended to transfer or transferred in any case despite a recommendation not to do so (so-called ‘insistent’ customers). Across all cases surveyed by FCA, including those where the recommendation was against transferring, the average transfer value was just over £350,000. This suggests the total amount transferred just in this period is likely to have been in excess of £50 billion. See: Defined benefit pension transfers – market-wide data results | FCA
