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take the remaining  pension as a tax-free lump sum, as long as it is in a draw-down account or no  funds have yet been withdrawn from it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.