Chancellor George Osborne has announced that a so-called ‘death tax’ on pensions will be scrapped
How will this work?
Hundreds of thousands of families are expected to benefit, to the tune of £150million each year.
From April 2015, if the person who dies is 75 or over, beneficiaries will only have to pay their marginal tax rate when they draw the income, as they would with any pension.
If the person who dies is under 75 there will be no tax to pay at all.
Currently, only spouses and financially dependent children under the age of 23 are exempt from the 55 per cent tax, and are instead allowed to withdraw the pension and pay their usual income tax rate
The expected structure of the change would see tax paid at 20 per cent, 40 per cent or 45 per cent on outstanding pension pots inherited.
Those who have already taken pension benefits will also benefit from the change, although those who have bought annuities will not as their capital is usually lost on death.
It has not yet been revealed how the tax cut will be funded although details are expected in the Autumn Statement.
In his speech to the conference Mr Osborne said the change will deliver freedom for people’s pensions. Not a promise for the next Conservative government, but put in place by Conservatives in government now.
People who have worked and saved all their lives will be able to pass on their hard-earned pensions to their families tax-free. The children and grandchildren and others who benefit will get the same tax treatment on this income as on any other, but only when they choose to draw it.
The move will make pensions even more attractive for long-term saving but is a further blow for annuities, whose relative attraction will be diminished once again. The Chancellor has already scrapped rules that force most Britons to use their pension savings to buy an annuity, making it easier and cheaper for people to withdraw money directly from their pension pots.
The first swathe of pension changes announced in his Budget earlier this year gave workers unrestricted access to their retirement savings. It means that workers retiring without a defined benefit pension – such as a final salary scheme – no longer have to use their pension pot to buy an annuity to provide them a retirement income. Instead they can either withdraw cash from their pension as or when they like, keep it invested and live off the income, or use a combination of the two.
As a result, millions more retirees are expected to opt for a process known as a drawdown, where their pensions remain invested while they take an income.
When a person uses drawdown and dies with their pension still invested, they can leave instructions for whatever is remaining in their pot to be paid out as a lump to whomever they wish. Until now this would incur a hefty 55 per cent tax – from next year no tax will be paid.
Could this make retirees more prudent with their pension’s freedom?
One of the fears over new pensions freedoms, set to come into force in April, is that retirees given access to their full retirement savings may spend too recklessly and leave themselves out of pocket in later life.
But this new move to remove the 55% tax charge could encourage savers to be more prudent with their retirement funds.
If the 55 per cent tax charge were to be retained beyond that date it might well encourage individuals to draw down their funds too quickly with a view to avoiding the possibility of having to incur this tax on their unused money. This could mean they run out of money and leave themselves short in their later years.
Would an annuity still be better for some?
These latest changes to the tax rules will be a mixed blessing. They will encourage investors to take the maximum possible advantage of their pension contribution allowances, which is certainly a good thing.
Investors can build up their pension fund, secure in the knowledge that they can not only draw on their savings without restriction from age 55 but in addition, any unused savings can be passed on to their inheritors tax free on death.
It is therefore likely to significantly boost demand for income drawdown in retirement and to diminish the relative attraction of annuities. It will also encourage investors to preserve their pension funds to meet the cost of care funding.
However, managing the withdrawal of income from a pension fund over the term of retirement is not simple and annuities still offer some advantages.
While pensioners would not be able to pass on any left over cash, an annuity does provide the certainty of income for the rest of your life that is vitally important to retirement planning.
Annuities carry two important advantages: they provide a guarantee of income for the rest of an investor’s life, however long that may be; they also allow investors to benefit from the ‘mortality cross-subsidy’, by sharing out some of the value of the pensions of those who die young, they increase the payments to those who live longer. This is an extremely efficient system.
You can contact us if you would like to know more about the recent changes in legislation, or to discuss your own personal circumstances