George Osborne had more good news for retirees and savers yesterday, as he brought forward the announcement that he is abolishing the 55 per cent tax charge applied to some people’s pensions on their death – the so-called pensions death tax. Coming into force in April 2015, and on top of previous pensions liberalisation, the new rules simplify the existing regime and remove a tax trap that has caught out many savvy investors over recent years. Ultimately, this should make pensions far more attractive as a long-term savings vehicle.
Until now, if you died before the age of 75, but hadn’t taken any of your pension, you could pay – via a trust – the whole pension fund to nominated beneficiaries free of inheritance tax. But just by taking 25 per cent of your pension at the age of 55 as a tax free lump sum, you would have exposed the remaining 75 per cent to a punitive 55 per cent tax charge if you died before 75. The only way to avoid the tax was if you had a spouse or dependent children under the age of 23 who could use the fund to draw an income for life. They would then pay tax on the income they drew in the normal way.
From April 2015, that 55 per cent tax charge will disappear, even for those who have already started to draw a pension. If you are under 75 at death, the whole fund can be taken as a lump sum by your beneficiary without tax.
There are further implications. If you die after 75, your beneficiaries can now inherit the pension and only pay any income tax as and when they start to draw any money. If your beneficiary has any unused personal tax allowances, they could in theory draw an income tax free.
This could make annuities less attractive. People who’ve bought a guaranteed lifetime annuity with their pension fund probably won’t benefit, as most annuities stop at death with all the capital lost. Any lump sums or pensions due to a spouse on the death of an annuity holder are mostly unaffected by these changes.
But for those with very large pension funds, or those who can afford to not drawdown their full pension, this rule change is of significant benefit, and it makes sense to review wills and financial planning immediately. Most pensions are written under trusts separate from your estate, however, and so aren’t bound by your will. It is therefore imperative you tell your pension trustees who you want to be a beneficiary, as you may have last looked at this question over 20 years ago.
There are still kinks to iron out. Between now and April, the industry and HMRC have to work out how to implement this. What if a provider does not offer flexible drawdown or does not allow drawdown for anyone other than a spouse or dependent child? The beneficiary might still have to take it as a lump sum and there may still be a punitive tax charge, possibly with no ability for the beneficiaries to claim back through their tax return.
But the government may also want to consider the impact on other financial products. These changes make pensions more attractive as a long-term savings vehicle. Given that the tax advantages of Isas are lost on death, the government may also wish to equalise the two by revisiting the current Isa rules.