Defined contribution pension savings that are passed on to surviving spouses or dependants will no longer be subject to a 55% flat rate of tax, under proposals announced by George Osborne yesterday. It follows on from the surprise announcement in the Chancellor’s budget speech, giving DC scheme members complete freedom to withdraw funds from their pension savings.
From April next year, the tax treatment of DC pensions will change, with different rules depending on how old the pensioner is when he or she dies.
- On death before age 75, a surviving beneficiary can take the remaining pension as a tax-free lump sum, as long as it is in a draw-down account or no funds have yet been withdrawn from it
- On death after age 75, the pension savings will be subject to the beneficiary’s marginal rate of income tax. However, if the beneficiary opts to take the whole pot as a lump sum, it will instead be subject to tax at 45%. The Government intends to consult about reducing the 45% rate to the beneficiary’s marginal rate by 2016/2017
It should be noted that the life-time allowance remains unchanged and the lifetime allowance charge would apply to any pension saving over the life-time allowance (currently GBP 1.25 million) on the death of a member.
Defined benefit schemes and annuities are not affected by these new rules. This prompts the question: what will be the likely implications of relaxing the tax regime for these schemes? The Government has already announced plans to relax the treatment of “guarantees” in annuities and this latest announcement could force insurers to further innovate to ensure annuities are a viable option at retirement.
There could also be increased interest in transferring out, for example, among pensioners who have adult children. So far, demand for transfers-out from DB schemes has not quite lived up to expectations following the announcement on income drawdown in March, according to Mercer. Its Pensions Risk Survey tracked a slight rise in requests for quotations before a lull in the summer months. However, this change could encourage members without a surviving spouse, civil partner or dependant children – and for whom there may be no further benefits payable on death than a “five-year guarantee” – to consider transferring out to allow pension savings to be passed on.
Relaxing the treatment of pensions on death may also act as an incentive for more pension saving.