The Chancellor, George Osborne, has announced that the Government is to abolish the current 55% pensions death tax. From April 2015, pensioners will have the freedom to pass on their pension pot to beneficiaries when they die, rather than the recipients having to pay the sizeable 55% tax charge which currently applies to inherited pension pots. In his speech, the Chancellor said “People who have worked and saved all their lives will be able to pass on their hard-earned pensions to their families tax free.”
David Hosford, Partner and Head of Pensions at Pitmans LLP welcomed the announcement, saying “Pensions are finally being given the high level attention and recognition that they deserve. The pension reforms of this year, which started with the radical announcements in April’s Budget to provide almost complete freedom to defined contribution members around the way in which they are able to utilise their pension pots, will give pension savers far more choice in the way in which they use their savings. Pension savers will be able to pay into their pension fund knowing that any unspent monies after their death, in some cases, can pass to beneficiaries without any tax being levied against it, instead of the current high 55% tax rate being applied.”
Under the current rules, where an individual opts to pass their pension to a beneficiary as a lump sum after their death, if the funds are already in a drawdown account, or if the individual dies aged 75 or over and the funds are untouched, a 55% tax charge is levied on the full amount. Where the funds are passed to a spouse or dependent under the age of 23, the pension monies can be drawn down at the beneficiary’s marginal rate of tax. If the individual dies before they reach the age of 75, an untouched pension pot can be passed to a beneficiary as a lump sum, without a tax charge being applied.
Under the proposed new rules, from April next year, if a pension saver dies before they reach the age of 75, their untouched or drawdown account defined contribution pension can be passed to anyone as a lump sum completely free of tax. Further, the beneficiary will not have to pay any tax when they begin to utilise the pension monies. Beneficiaries who inherit defined contribution pension pots from a scheme member who dies aged 75 or over, will be charged at their at their marginal rate of income tax if they opt to drawdown and utilise the pension monies. There will be no restriction on the amount, or the age at which they can withdraw. If they chose to receive the pension as a lump sum, this will be subject to a tax charge of 45%.
The new rules will have the effect of making those who inherit pension savings, subject to the same tax regime as the individual whom accumulated the pension savings in the first instance. Beneficiaries will be able to take the money by way of regular drawdown payments or one-off sums, but only paying income tax at their marginal rate in any case.
The changes proposed by the Chancellor will allow people to use pension savings in a more creative way. Money passed on through pensions is now likely to form part of wider inheritance tax planning, rather than being seen as an inefficient way in which to leave a legacy. The lower tax rates to now be applied will make pensions a much more attractive way of providing for loved ones after death, as they are not included in the calculation of a deceased’s estate for inheritance tax purposes.
Whilst the tax saving will undoubtedly be seen as a blessing for many, it signifies another step towards the extinction of annuities. Unless a guarantee is attached, any money used to purchase an annuity cannot normally be passed to a beneficiary after death. Conversely, the proposals here are likely to boost income drawdown, as funds in drawdown will be able to be passed on tax free. Pitmans LLP remain of the view that only time will tell if the shift away from the traditional method of buying annuities is for the better, but welcome the emphasis being placed on pension savings by the Government and that savers have been given an opportunity to utilise their savings with much greater freedom and autonomy.
David Hosford comments, “Pension provision is radically changing, and all stakeholders must ensure they keep up to speed. Employers will need to continue to ensure that their schemes are commercially viable and valuable to their employees, allowing members to make the most of these changes. Trustees should be prepared for an increase in enquires from scheme members about the new system, and potentially amending their beneficiary nomination forms as part of their wider legacy planning. Ensuring that scheme records are kept accurate and relevant with regards to beneficiaries is of course crucial. The next few years look set to mark a real sea of change for all across the pensions industry. It remains to be seen how the recent proposed changes to pensions will work in practice, but we are excited, optimistic and confident that members will benefit and be duly rewarded for their choice to save and plan for the future.”