Pension tax on death is what the Treasury takes from your personal pensions when you die. If you are under age 75 and die before taking any pension benefits, the value of your fund will normally be paid to your nominated beneficiaries as a tax-free lump sum. If however you die after age 75, and have still not taken benefits, any lump sum death benefits will be taxed at 55%.
Once you have started taking income from your pension fund however, the remaining pension on death may be paid as a lump sum which will be taxed at 55%. The 55% charge does not apply if your fund is paid out as a spouse/civil partner or dependant’s pension. They are instead taxed at their highest marginal rate on any income drawn from the pension.
As not everyone is fortunate enough to leave pension funds untouched as a savings vehicle, because they are to provide income in retirement, many pension funds face this 55% tax charge, particularly on second death where there is no spouse to continue to draw the pension as an income.
To rectify this, the Chancellor has just announced that this tax penalty is going to be scrapped in April 2015. This means that pensions will be able to be passed on to heirs free of tax on death prior to age 75 whether you’ve accessed pension benefits or not. Even on death after 75, the 55% tax charge is still avoided but any withdrawals from the pension are taxed at the beneficiaries’ highest marginal rate. Alternatively they could draw the pension as a lump sum but this would be subject to a 45% tax charge. There are proposals, but these are subject to further engagement, to reduce this 45% tax charge to the beneficiaries’ highest marginal rate.
On the back of the proposed changes to make pensions, this gives further planning opportunity. It was an area clearly misunderstood by many, causing those who have taken elements of their pensions to pass on a large tax bill upon death to their beneficiaries.
Potentially it removes another excuse for not investing in pensions which are very tax efficient savings vehicles, so it could encourage more people to maximise their contributions. The demand for income drawdown will further increase whilst it is likely to diminish the attraction of annuities; this highlights the need for advice, as annuities may still be a better choice in some instances,especially with legislative changes being introduced to open up the flexibility of annuities, removing much of the rigidity associated with them in the past.
It also strengthens the possibility of continuing to fund pensions in retirement up to age 75 as part of an overall estate planning/ inheritance tax avoidance strategy.
Now may also be a good time to review and update wills, and to ensure that any pension payments upon death go to chosen beneficiaries according to your own expression of wishes.
However, as always, the devil is in the detail, and as this further detail is released, there can often be refinement. So we’ll keep an eye on it for you and report back. As always advice is paramount and bespoke, and as always, we’ll consider some of these strategies as they arise as part of your review.