Tens of thousands of people a year face losing out under the proposals to remove an exemption for all those who inherit untouched pension pots.
Campaigners have branded the move “extremely unfair”.
The plan was slipped out in a flurry of documents published as MPs left parliament for the summer recess and have now gone out to consultation. Sir Steve Webb, partner at the consultants LCP, said: “The small print of these proposals contains a ticking time bomb for people planning their family finances.
“If there is not a big response from the public to this consultation, the Government will go ahead with a change that could result in a tax hike for people on modest incomes who inherit a pension pot.”
Untouched pensions can be passed on without triggering inheritance tax. Beneficiaries are subject to income tax if the pensioner dies after the age of 75.
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But reforms introduced nearly a decade ago by then chancellor George Osborne meant the pots of those dying aged 74 and under could be transferred without income tax being imposed on withdrawals.
It meant heirs could inherit the pension, leave it to grow and draw it out free of tax at any time.
Under the proposals, the tax break would be scrapped from April next year. It would mean recipients would have to take the inheritance as a cash lump sum to keep it tax free. That would leave people with difficult decisions about how to invest the money and manage it over time.
Sir Steve, a former pensions minister, said: “It would be totally unacceptable to make such a big change through the back door.
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“If ministers plan to remove this pension tax break they should announce their plans publicly and have them properly debated.”
A Treasury source said: “This is not a done deal. The document only outlines one suggested approach as to how lump sums could be taxed in the absence of the lifetime allowance.”
The consultation was largely focused on legal changes needed to implement the abolition of the lifetime allowance, which capped tax-free pension savings at £1.073million, announced in the Budget. But that reform helps only the wealthiest, while the new proposals would apply to anyone who inherited an untouched pension from a loved one who died under 75 – regardless of the size of the pot.
Campaign group Silver Voices said the move was particularly unfair on spouses. “If the main breadwinner dies, the other spouse or partner should inherit the pension,” said director Dennis Reed.
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“It’s extremely unfair and I feel for those who are bereaved and assume they will inherit the pension pot without income tax.”
The proposals were among a bundle of tax consultations published by the Government, which said it was working on legislation to “ensure our historical pensions tax cut delivers the right results for savers and the economy”.
Baroness Altmann said: “It seems to make good sense to remove the anomaly between those who die before and after age 75
“The pensions still pass on free of tax to the inheritors but if tjhey take some money out they pay tax at their marginal rate. Pensions are a brilliantly tax efficient way to provide for later life .”
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