In a surprise move, the Chancellor George Osborne, has announced a major overhaul in the tax treatment of pension death benefits.
The announcement is the missing piece of the jigsaw following the dramatic changes announced in the Budget and the detailed rules revealed earlier in the summer.
The change has taken the pension industry by surprise, with many experts suggesting it has the potential to revolutionise retirement planning for both older and y9ounger generations.
Current pension ‘death tax’ rules
Under the current rules the amount of tax paid by the beneficiaries of a money purchase pension, for example a Personal Pension, Stakeholder Pension, Self-Invested Personal Pension and some workplace schemes, depends when the individual dies:
- Death before retirement 100% of the pension pot is available as a tax-free lump sum providing death occurs before the age of 75. If an individual dies after the age of 75, but before taking benefits, tax is payable on any lump sum at a rate of 55%
- Death after retirement where Income Drawdown is used If an individual takes benefits from their pension using Income Drawdown, any lump sum paid out on death, except those to charity, will be taxed at a rate of 55%
Individuals who chose to turn their pension pot into an income by using an Annuity don’t generally have the option of leaving a lump sum on their death.
Proposed new ‘death tax’ rules
The new rules will significantly reduce the amount of tax payable on death, although contrary to some news articles, it won’t be completely abolished, simply because most of us die after the age of 75:
- Death before the age of 75 Now completely tax-free, irrespective of whether the individual as retired
- Death after the age of 75 Where beneficiaries elect to take a lump sum, a 45% tax charge will be made between 6th April 2015 and 5th April 2016; thereafter tax at the beneficiaries marginal rate will be paid. If a pension income is taken rather than a lump sum, the beneficiaries will simply pay tax at their marginal rate.
The new rules will therefore allow anyone dying before the age of 75 to pass on 100% of their pension fund to whoever they wish. And whilst not abolished, the rate of tax payable on death after the age of 75 will fall significantly.
The rules for Annuities will remain unchanged.
Old and new rules compared
These handy charts, produced by AJ Bell, explain more about the options and potential taxes payable on death.
Older generations will no doubt welcome the idea of being able to pass more of their pensions on to their dependents. But the big winners are younger generations, who will inherit a larger lump sum, which could boost their own pension, at a time when they are financially stretched.
According to the Government, 320,000 people will be affected by the new rules, which are likely to see Income Drawdown become an increasingly popular option in retirement.
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