George Osborne announced some very welcome news on the 29th September, abolishing the 55% tax charge applicable on death to pensions in retirement.
Recap of the Rules
Previously, if you were drawing your pension using income drawdown, then any lump sum death benefits would be subject to a 55% tax charge. This would apply if your spouse or dependent decided to take a lump sum, or if the beneficiary was not a dependent. For example, on first death the surviving spouse may decide to continue in drawdown, but on second death the fund would have been subject to a 55% tax charge before being paid to the beneficiaries (e.g. the children).
The tax charge also applied to pension funds that had not been accessed (known as “uncrystallised” funds) if death occurred after age 75, which based on average life expectancy is more likely. This caused a situation where people were drawing their pension without actually needing the income, to minimise the impact of the 55% tax.
With immediate effect (provided the death benefit payment is made after 2015), the new rules are as follows:
Death before 75
The pension fund can be taken as a tax free lump sum by the beneficiary(ies). This could be all at once, or in instalments, and there will be no income tax charge on the withdrawals.
This will apply to both crystallised and uncrystallised funds, so it does not make any difference whether or not you have started drawing your pension. There will be no tax charge. This means those in drawdown will see their potential tax charge on death cut from 55% to zero overnight.
Many beneficiaries will want to take the fund as a tax free lump sum, but it could remain invested and act as a source of income. The pot will continue to benefit from the favourable tax treatment of normal pension funds. It could therefore provide beneficiaries with a sustainable stream of income whilst the funds grow tax free and remain outside their estate for Inheritance Tax.
Death after 75
If death occurs after age 75, the treatment will be different. There will still be no tax charge at the point of death, but the fund the nominated beneficiary(ies) “inherits” will be subject to income tax charges on any withdrawals. If the entire fund is taken as a lump sum, then there will be a 45% tax charge, although this may be reduced after April 2016. If the beneficiary(ies) takes the withdrawals as income, these withdrawals will be taxed as income at the recipient’s marginal rate.
The beneficiary(ies) could take the whole fund as a cash lump sum, but this is unlikely to be the best course of action because of the income tax implications. Instead, the income tax could be minimised by staggering the withdrawals over a period of time.
For those with Personal Pensions and SIPPs, particularly those in drawdown, a review of the nomination made needs to take place to ensure this remains suitable under these new rules. It may also result in a change of strategy for those drawing an income.
David Penney, 30th September 2014