29th September 2014
In his latest salvo on the retirement industry, the Chancellor George Osborne has declared that the government is tearing-up the 55% death tax on pensions rule.
From next April pensioners will have the freedom to pass on their unused defined contribution pension to whom they please when they die, rather than paying the 55% tax charge which currently applies to pensions passed on at death.
Under the present rules, pension savings can be taxed at a 55% tax rate where a person dies aged over 75. In addition, in the case of someone dying before age 75 – and they had started to take withdrawals from their pension fund i.e. is using income drawdown or has taken tax free cash – the 55% tax rate applies to the part of the fund that has been touched.
However under the new proposals, there will be no tax to pay on an inherited pension fund where someone dies before age 75. Where someone dies after age 75, the rate of tax due on the pension fund would be determined by the income tax position of the person inheriting the pension.
Around 320,000 people retire each year with defined contribution pension savings but these people will now no longer have to worry about their pension savings being hit with a 55% tax on death.
We round up the expert reactions…
Standard Life, head of customer affairs. Julie Hutchison:
Pensions are now truly effective for income and inheritance tax planning. It creates a genuine incentive to save, knowing your loved ones can benefit too, helping older family members support younger generations who find it harder to save. The savings revolution, which began in March and continues with today’s announcement, now places pensions firmly centre stage. Our research shows that being able to leave pension funds for your loved ones is a priority for people in the UK. Back in May, we called for the flat rate 55% death benefit tax to be reduced and replaced with a rate that was fairer and linked to someone’s overall wealth. We’re delighted that the new proposals take this differentiated approach, which takes account of the wealth of the individual rather than a “one size fits all” tax policy.
Aviva’s head of Policy, John Lawson:
UK consumers will have even more choice in how they use their pension savings with the ability to pass on their savings tax free to their family and friends. The new rules will provide away of enabling consumers to plan for and pass on their pension savings, without penalty. However, with the new pension freedoms coming into effect from April next year, people need to think carefully about their retirement choices, and inheritance is only one of the factors that should be taken into consideration. Savers should consider how much of their savings will cover their core retirement living costs for the remainder of their lives. In these cases having a guaranteed income, as offered by an annuity, may be the best option. For most people with average pension pots, these changes will not be so relevant. For savers with bigger pots, a mix of products may enable them to keep some of their money in their pension scheme, which benefit from the new rules and can be passed on to their loved ones with no tax.
Association of Investment Companies (AIC) director general Ian Sayers
This change will be welcomed by many consumers. Our recent research on the pension changes revealed how important the ability to pass on pension assets was to consumers. 44% of consumers were more positive on pensions due to the changes and a key reason for this was the ability to pass on assets when they die. Interestingly, over two thirds of those surveyed were discouraged from purchasing an annuity because they could not pass anything onto their family and friends. This change will encourage more people to draw an income from their pension fund in retirement with a view to passing on assets to their loved ones on their death. With their unique advantages over other funds when it comes in delivering a higher or growing income in retirement, investment companies should be considered as part of a long-term, balanced income portfolio.
Aegon regulatory strategy manager Kate Smith:
The removal of the draconic death tax is good news for most pension savers, and coupled with the new retirement flexibilities, will make income drawdown even more attractive when compared to annuities. People need to know exactly what will happen to their pension fund on death, and now we have the missing piece of the jigsaw. If a pension saver dies before age 75, even if they have started to take some payments, they will be able to able to pass on their remaining pension funds tax free to their children and grandchildren. And on death after age 75, beneficiaries will pay income tax at their marginal rate, only once they start taking the money.
Drawdown, rather than annuities benefits from these changes. If customers take out an income drawdown product they can decide who will benefit in the event of their death, unlike annuities where the amount is absorbed into the insurance company’s annuity pool for the benefit of other annuitants. For those people whose loved ones were in drawdown and who die before April 2015, the beneficiaries may wish to delay taking any payments as depending on the deceased person’s age, these may be tax free if they hold off until these changes come into place. People are far less likely to empty their pension pot in the early stages of retirement purely to avoid the death tax now.
Association of British Insurers assistant director Dr Yvonne Braun:
Providers will wholeheartedly welcome this change which we had asked ministers to consider. A 55% tax charge if someone dies before they have accessed their pension fund goes against the grain of the wider Government policy of making pension saving more popular by giving people more options on how to use their retirement savings. This is a sensible move which deserves support.
AXA Wealth head of retirement planning Andy Zanelli:
2014 is definitely shaping up to be a year of monumental change in the savings and pensions market. This latest move by Osborne is yet another boost to the drawdown market, which is already set to benefit from the changes announced in this year’s Budget and due to come into force in April 2015. This move certainly builds on the government’s commitment to bring simplicity and flexibility to pensions. While this is positive news for the most part, it is important to remember there are a number of key financial planning considerations. First, as the majority of people die after age 75 any funds that remain in their pension will be subject to the marginal rate of income tax. Second, there is no clarity as to whether the remaining money in a pension pot needs to be taken as a single lump sum, if this is the case it will push a number of people into higher rate tax. With a number of changes coming up for the savings and pensions market, it is more important than ever that those planning for retirement seek professional financial advice.
Partnership chief executive Steve Groves:
This is excellent news for the more affluent retirees but with the average pot used to purchase an annuity standing at £30,000 it is unlikely to be applicable to the vast majority who will use all their funds to make ends meet – during increasingly longer retirements. Choosing to go into drawdown in order to preserve a proportion of their pension income as an inheritance could be disastrous for those who live longer than expected. We expect to see more people focus on using an annuity to secure a guaranteed minimum income which would then give them the freedom to use their other assets as they see fit – without gambling their future security. Those who choose an enhanced annuity can benefit from up to 40% more income for life compared to those who don’t shop around or take a standard product. Longer term, the announcement from the Chancellor may encourage wealthier people to save more into their pensions.
Hargreaves Lansdown head of pensions research Tom McPhail:
The news should boost investor appetite to save in a pension now, as under this new regime they can draw on the funds at will from age 55, use them to pay for long term care and pass any residual funds on to their inheritors. Critically, the Treasury has confirmed that beneficiaries of these ‘pension bequests’ will be free to draw on these bequeathed funds as soon as they receive them, even if they are under age 55: they will simply be liable to income tax on the withdrawals.
It is likely to give a boost to demand for transfers out of final salary pension schemes. This is because scheme incomes generally cease on the death of the member and their spouse; the option of passing on a share of a pension fund to children may prove very attractive, particularly as a final salary income of £10,000 a year would be worth something in the region of £300,000, for example.
What should investors do now? Anyone who wants the certainty and simplicity of an annuity should go still go ahead and buy one, provided they have shopped around for the best possible deal. Anyone who is happy to take on some investment and life-expectancy risk in retirement and who is interested in passing money on to their beneficiaries should look at using drawdown instead. Investors can go ahead and make use of drawdown today, secure in the knowledge that they’ll be able to take advantage of these freedoms from next April.