Pensions can now pass to next generation tax-free
People are now able to pass their pension fund onto the next generation free from tax, chancellor George Osborne has announced.
Previously, when pension funds were passed onto beneficiaries, a 55% tax penalty was payable, but Osborne has abolished this from today (29 September 2014).
It means that no tax is payable when a defined contribution pot is left to a beneficiary, whether the deceased had withdrawn funds or not.
If beneficiaries spend the pension fund (rather than keep it invested as a pension) they will pay their marginal rate of income tax, but only if the deceased was 75 or older at the time of death. If the deceased was under 75, there would be no income tax to pay in this scenario.
It is the latest in a series of bombshell pensions announcements made by the government. In March, Osborne said in his Budget speech that from April 2015 retirees would have total freedom over how they withdraw their pension, allowing them to take their pension as cash, leave it invested or buy an annuity with it.
The latest announcement means income drawdown, where retirees invest their pension assets and live off the income, will become even more appealing as retirees will know they can now pass on the proceeds of their pot tax-free.
The abolition of the death tax charge is far more radical than the industry had anticipated, with many financial advisers expecting a cut in the tax to 40%.
More good news
Dr Ros Altmann, the government's champion for older workers, welcomed the announcement: "The good news on pensions just keeps on coming. This will encourage more people to keep more money in their pension funds for longer. This should benefit them in later life, especially if they need to pay for care. It will deter people from spending their pension money straight away, since money withdrawn will be subject to income tax." You can see her helpful table below for how the new tax rule might affect you.
Tom McPhail, Head of Pensions Research at Hargreaves Lansdown, said: "These changes to the tax rules 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."
People who have already taken pension benefits will benefit from the change, although those who have bought annuities – where you convert your pension into a guaranteed income for life – will not benefit as their capital is usually lost on death.
Altmann said this is "another nail in the coffin for annuities", but McPhail pointed out that annuities still enjoy two distinct advantages over other retirement products.
He explained: "Annuities 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."
Osborne's announcement was broadly welcomed by the financial services industry. Alan Higham, retirement director at Fidelity Worldwide Investment, said: "This was a poorly understood area which tripped up a number of people who inadvertently caused their loved ones to pay huge sums of tax on their death soon after retirement.
"People will no longer have to choose between taking some tax free cash now or putting it off until later for fear of triggering penal death duties.
"When you die, most pension funds pay any remaining money to your beneficiaries according to your own expression of wishes. It is important to make sure all your pension funds have been notified of who you would like to benefit. Everyone should consider their choices again as a result of these changes."
|Die before age 75 Old system||Die after age 75 Old system||Die before age 75 New system||Die after age 75 New system|
|Pension fund passed on (as a pension) if no money yet withdrawn||Tax free||55% tax||Tax free||Tax free|
|Pension fund passed on (as a pension) if tax free cash taken or in drawdown||55% tax||55% tax||Tax free||Tax free|
|Tax payable if funds passed on are spent rather than kept in a pension||Marginal income tax||55% tax||Tax free for anyone||Income tax|
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.