The death of the death tax

October 10, 2014

What is pension death tax?

Under current rules, if someone dies over the age of 75 and their dependents are 23 or older, the Government takes a massive 55 percent of what remains in their pension pot as a ‘death tax’. That’s a huge chunk.

Currently, it’s only possible to pass your pension pot to a beneficiary tax-free if you die before 75 and have not taken any tax-free cash or drawn an income.

What’s changing?

In the latest announcement on the overhaul of pensions by the Government, Chancellor George Osborne outlined his plans to scrap the death tax from next April.

Under the new rules, any beneficiaries will now only pay the marginal income tax rate, and only when they take money out of the pension.

If the deceased was under 75, access will be tax-free, including if income has already been drawn from the fund while it is still being invested.

What does the end of the pension death tax mean?

The upshot of all this is that the more you save into your pension, the more flexibility you’ll have over what you can do with it. Pensions are becoming a much more attractive proposition.

Good news for ordinary savers: Many people can’t afford to leave their pension funds untouched until the age of 75. In the past, this has meant their loved ones would have been hit with the 55 per cent tax on anything that remained in the pot once the saver dies. Now, regardless of their means, pension holders can be happy in the knowledge that their hard-earned savings can pass to their loved ones without the gigantic tax penalty.

Good news for families: A pension saver can now leave their pension pot to their offspring, tax free, who can leave it to their dependents and so on. The money has to stay within a pension to be tax-free, but this inter-generational pension saving ensures long term financial security for families. Alternatively, the family can access the money straight away and simply pay income tax on withdrawals at their own marginal rate. A pension is no longer just for the life of the individual saver.

Reduced reliance on annuities: At present, one of the few ways to ensure your spouse/civil partner continues to get an income from your pension pot if you die is to buy a joint life annuity. With no death tax to pay, there’s now another way. The pension pot can stay invested so it continues to grow and then be passed on.

Is there a down side?

As with all such announcements, the Chancellor’s plans have come in for some criticism. Is this simply another way for better-off savers to escape tax? At present, most people in the UK reach retirement with fairly modest pensions and have to focus on the here and now rather than being able to pass large sums on to their loved ones. The removal of the 55 per cent tax will have little impact on them and their families. Those who can afford to will be able to use their pension as another way to protect up to £1.25m from some or all tax after death. For these people, a pension could become a way to preserve savings beyond the grave rather than being a means of spreading income over their lifetime.

The other concern is around the potential impact this move may have on tax relief. At the moment, all pensions’ contributions benefit from tax relief which means that for every £6 you save, you get £10 in your pension pot (if you’re a 40% taxpayer).

In the past, the trade-off has been the complex rules around how you can then access your money. With those barriers being removed, will we see a reform in tax relief as the Government seeks to cover the loss of revenue caused by the removal of the death tax? We will wait to find out.

What you should do now?

With options galore relating to your pension now, it pays to take a bit more interest in it!

  • Check your will: make sure it’s up to date with your pension death benefit nomination so that your pot goes to the right person/people when you die
  • Get some sensible tax planning: this may extend beyond you and to your immediate family to make sure tax efficiency is maximised
  • Get advice on your pension: with increased flexibility come increased options. And it doesn’t always mean that the old routes (e.g. buying an annuity) are wrong for you. Get some professional advice to help you choose the best options for you, your pension pot and your loved ones.

Overall, we think this announcement is a positive move. With the end of the death tax comes renewed life for pensions saving, and that kind of long term planning can only be a good thing.

If you have any questions about this article call Bob Wilson at GreenSky Wealth on 01603 340800.

 

This article is for general use only and is not intended to address your particular requirements. It should not be relied upon in its entirety and shall not be deemed to be or constitute advice.

GreenSky Wealth Ltd is an appointed representative of Financial Limited which is authorised and regulated by the Financial Conduct Authority. FCA No: 516410