Rachel Reeves is facing growing calls for an inheritance tax on pension funds to help fund spending promises.
Economists are urging the new Labour chancellor to introduce a death tax on unspent defined contribution (DC) pension funds.
Defined contribution pension plans are currently not subject to inheritance tax.
But Ms Reeves is under pressure to tax pension funds the same as other assets when someone dies.
Bill Dodwell, former director of the Office for Tax Simplification, said: “There has never been a good reason why pensions inherited from someone who died before the age of 75 should not be subject to income tax. After all, the original pension holder received tax relief on the pension contributions.”
The standard inheritance tax rate is 40%.
David Sturrock, an economist at the IFS, said: “The current system provides incentives to hold on to pension wealth and use other assets to fund retirement.
“This leads to a rather perverse situation where pensions are used as a vehicle for inheritances rather than to fund retirement.
“In terms of the inheritance tax revenue that would be generated by the integration of pension funds into inheritance tax, the impacts would now be modest.
“We estimate that around £200m more could be raised now. But the importance of this special treatment is set to grow rapidly as more people retire with assets in defined contribution pension pots over time and the sums at stake become larger.
“Over the next decade, we estimate that the revenue generated by bringing pension funds within the scope of IHT could be in the order of £1 billion to £2 billion.”
Former pensions minister Sir Steve Webb added: “Any review of pension tax relief is likely to look at the favourable tax treatment of pensions when a person dies.
“The government may consider ending the way wealth held in ISAs is counted as part of an estate, but pensions are not. This could be particularly interesting as more people are saving in ‘pot money’ pensions, meaning the tax loss from excluding them from IHT is likely to increase.”
Adam Smith, Mr Hunt’s former chief of staff, said Treasury officials had recommended the move in the past.
He said: “Removing the tax relief available for farmland and businesses and including pensions in a person’s taxable estate would raise between £1bn and £2bn a year and was an option we considered to raise revenue and fund a reduction in the overall IHT rate. Labour will obviously not do the latter, but it may need to do the former.”
A new report from the think tank Demos says Britain is “unusual” globally in allowing pension wealth to be passed on tax-free and should consider scrapping or limiting the relief, as savings pots have become a way of passing on wealth, rather than saving exclusively to cover living costs in old age.
According to Demos, “taxing inherited pension assets makes economic sense because pensions are currently treated more favourably by the tax system if they are given as bequests than if they are used as retirement income, which is what they are intended for.”
