One of the most significant changes under the new pension rules concerns the ‘death tax’. This is the 55% tax charge that can occur when your unused pension wealth is passed on to a beneficiary as a lump sum. It applies at the moment if you have already started taking benefits from your pension and/or you die over the age of 75.
From 6 April 2015, the death tax has been abolished, and a new set of rules applies. Any remaining pension wealth that you have not used to buy an annuity can be passed on to any beneficiaries you choose (not just financial dependants). The tax that applies will differ based on the age at which you die as shown in this table.
Your beneficiaries will have the following options:
|If you die before age 75:
||If you die after age 75:
|Take the whole pension tax free
||Take the whole pension minus tax at 45%*
|Use it to generate an income by buying an annuity (provided the benefactor died on
or after 3 December 2014)
|Use it to generate an income by buying an annuity, paying tax at their marginal rate
|Use it to generate a future income by investing it in an income drawdown product
on which all income payments can be drawn
|Use it to generate an income by investing it in an income drawdown product, paying income tax on the amounts withdrawn
*From April 2016 the lump sum will be taxed at the beneficiary’s personal income tax rate.
Passing on wealth from annuities
Death benefits were previously paid out from an annuity if you have a joint life or value protected policy, or if you die within a guaranteed payment period. Under the old system, beneficiaries of joint life and guaranteed term annuities paid income tax on the benefits they received, while recipients of the lump sum received from a value-protected annuity paid tax at 55%.
From 6 April 2015, if death occurs before the age of 75 with a joint life, guaranteed term or value protected annuity, your beneficiaries will be able to receive any future payments from such policies tax free. If you die after turning 75, normal income tax will apply to the annuity income inherited by your beneficiary. If the lump sum is taken from a value protected annuity it will be taxable at 45% if received in the 2015/16 tax year or at the recipient’s marginal rate of income tax if received in later tax years.
Passing on wealth from income drawdown products
The death benefits on offer with income drawdown pensions have tended to be viewed as more beneficial than those with annuities. However, the rule changes being introduced in April 2015 will create a more level playing field.
Previously, if you had a drawdown plan and you died, your beneficiaries had three main options. They could continue to take your remaining fund as income drawdown, opt for a lump sum or simply convert the fund to an annuity as you would with any other pension fund.
Before 6 April 2015, beneficiaries choosing to take a lump-sum payment would be subject to the 55% tax charge. Now they will receive the lump sum tax-free if you die before the age of 75, or pay a 45% tax charge on it if you die on or after age 75.
If your beneficiaries choose to continue with income drawdown, they can take income payments from that fund free of tax if you die before age 75. If you die aged 75 or over they will have to pay income tax on all payments they receive.
How the new rules create new possibilities for tax planning
The changes to the taxation treatment of remaining pension savings, plus the other new rules outlined above, could mean that, from April 2015, your pension is a more effective way to pass on wealth than using other assets. If you have a significant amount of wealth tied up in non-pension assets such as investments or property, you may find that, by using those to fund your everyday expenses and leaving your pension untouched for as long as possible, you end up being able to leave a greater legacy to your loved ones – and less to the taxman.
It’s important to remember, of course, that tax planning is complex and you’ll probably need help from a financial adviser to determine what kind of strategy might be right for you. If you don’t yet have a financial adviser but are interested in finding one then you can find out more here.