Pensions Death Tax Bites The Dust

Pensions Death Tax Bites The Dust
Galapagos by Julian Cohen. Why?

2014 has already been a momentous year for pensions and scrapping the death tax makes it even better

The Government Has Just Announced It’s Scrapping The Pensions Death Tax

The New Pensions Death Tax Rate Is Zero

The current death tax rate is 55 per cent.  It’s a charge applied to your pension fund on your death if you’re in drawdown, or if you die after age 75 whether you’re drawing your income or not. 

Death tax doesn’t apply if you’ve bought an annuity.  Instead, it could be argued you’ve suffered a 100% ‘tax’ on your pension fund.  That’s because the people you leave behind normally don’t see a penny of your pension fund, as you’ve given it to an insurance company in return for an income.

A cut in the death tax was expected, with many industry commentators suggesting it could be reduced to somewhere between 20 and 45 per cent.  But almost no-one predicted the death tax would be abolished.

In another headline grabbing move related to pensions, George Osborne scrapped the death tax altogether, saying:

“People who have worked and saved all their lives will be able to pass on their hard-earned pensions to their families tax free.  The children and grandchildren and others who benefit will get the same tax treatment on this income as on any other, but only when they choose to draw it down. Freedom for people’s pensions. A pension tax abolished. Passing on your pension tax free.”

The Treasury, which has been reviewing the death tax since the Budget, estimates it will cost £150m a year and affect 320,000 people.  The change comes into force in April 2015.

Dumping The Death Tax Should Encourage You To Save

As it’ll now be possible for pension funds, including those already in drawdown, to be passed on without a death tax of any sort, it’s another reason why you should consider saving the maximum in pensions. 

Not only will you be able to draw on your savings without restriction from age 55, you’ll also be able to pass on the remaining value of your pension fund to those you leave behind, free of death tax.*

It seems totally reasonable that any income you draw incurs Income Tax at your marginal rate.  And in keeping with the Chancellor’s view that your pension fund is your money to do as you wish, he’s proven his commitment to this by allowing you to pass it on to future generations, death tax free.  Your beneficiaries will simply pay Income Tax at their marginal rate on withdrawals they take from your fund.

Pensions consultant Dr Ros Altmann agrees with the death tax cut, suggesting it could open up the possibility of pension pots being used to pay for care.  She said:

“This addresses one of the biggest fears from the initial announcement on pension freedoms – that there would be reckless spending and you’ll have nothing left. Removing this 55 per cent tax charge means there is a huge incentive now to keep funds in your pension pot.”

It’s probably another nail in the annuity coffin.  Whilst it clearly suits some people to have the security of a regular income, when interest rates are low, buying an annuity comes at a huge price: the loss of your pension fund.  If you go into drawdown, you keep your pension fund in tact, subject to the valuation of the assets you hold.

Why The Government Has Scrapped The Death Tax

Treasury Financial Secretary David Gauke said:

"Our pension reforms mean people do not need to annuitise automatically, which creates a greater variety of pension pots and savings at death.

Therefore, the likelihood is that more and more people would have been caught up in a 55 per cent charge. That 55 per cent charge would come under much greater scrutiny as it is a pretty punitive rate. As we made clear [at the Budget] we needed to reform it.

We looked at the various options and it seemed to us that it wasn’t sensible to have a big distinction behind the treatment of a crystallised pension pot and an uncrystallised pot. There was a strong case for consistency.

If people died under age 75 with an uncrystallised pot then there was no charge to them. We didn’t want anyone to be worse off so the next logical step was to apply that to crystallised pension pots too.

You are then left with the question of what you do with over 75s. Our view was that the idea of charging a marginal rate [to beneficiaries when they withdraw cash] seems fair.

The overall effect of these reforms is that people will have more flexibility at retirement. That is something we should welcome. We know we have a problem in this country that we don’t save enough.

For a relatively small amount of money - £150m, which is driven not by the tax cut but by the cost of pensions tax relief from people saving more - we believe it is the right thing to do in terms of a cultural shift."

A Word About The Ultimate Death Tax – Inheritance Tax

Pensions are usually held in trust outside your estate and therefore Inheritance Tax isn't usually applied. This is the case under both the current rules and the new rules.

So if you're one of the people thinking of grabbing hold of your pension fund to avoid paying 55 per cent death tax, think again. 

It simply doesn’t make sense to draw out your fund, incurring marginal rates of Income Tax in the process, which could be as high as 45%.  For once the money is in your Estate, it’s then subject to Inheritance Tax, which is currently charged at 40%. 

A real double whammy, if ever there was one!

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* Proposed from the tax year 2016/17. In the tax year 2015/16, a 45 per cent charge will be applied if the whole fund is drawn as a lump sum (marginal tax will be charged on withdrawals).