As announced by the Chancellor George Osborne on the 29th September, from the 6th April 2015 individuals will have the freedom to pass on their unused defined contribution (DC) pension savings to any nominated beneficiary when they die,
and the current 55% tax charge that applies to lump sums paid from drawdown funds (when death occurs both before and after age 75) and uncrystallised funds (when death occurs after age 75) will be abolished.
There will also be a relaxation to the tax treatment that will allow a beneficiary (and not just a ‘dependant’ of the deceased) to receive tax free withdrawals from a drawdown pension if the original member (or last drawdown account holder) died before age 75.
The Governments pledge to ‘abolish’ the 55% death tax on pensions is not all it seems though because pension pots inherited when the member (or last drawdown account holder) dies after age 75 will still be subject to tax.
How can pension death benefits be paid after 6 April 2015?
On the death of the scheme member death benefits can be paid as either a lump sum or kept within the scheme and be taken as income drawdown.
Where the person entitled to drawdown dies then it will be possible for another beneficiary to continue in drawdown or for a lump sum to be paid. For someone who is not a dependant of the member there will be a new category of recipient called a nominee (who can be nominated by either the member or the scheme administrator).
Additionally, where a dependant or nominee dies then a successor can inherit the pension fund. A successor can be nominated by either the dependant, nominee or even a previous successor.
How will the death benefits be taxed?
Member dies before age 75
The punitive 55% tax charge that currently applies to lump sum death benefits paid from drawdown arrangements will be abolished altogether. Any such lump sum will instead be tax-free.
Like now, any lump sum death benefit paid from uncrystallised rights on death before age 75 will continue to be tax free (as long as the lump sum falls within the deceased’s available lifetime allowance).
Furthermore, from the 6th April 2015, where the funds are designated to provide a dependant’s /nominee’s flexi-access drawdown account then any withdrawals taken by a dependant or nominee where the original member died before age 75 will also be tax-free in the hands of the recipient, provided the funds are designated to the drawdown account within a two-year period.
It is important to be aware, however, that dependant’s drawdown pensions that are already in payment prior to the 6th April 2015 will be taxed under the current rules as that was the legislative position when the income commenced.
The Chancellor also confirmed in the Autumn statement that, from April 2015, beneficiaries of individuals who die under the age of 75 with a joint life or guaranteed term annuity will be able to receive any future payments from such policies tax free. The tax rules will also be changed to allow joint life annuities to be passed on to any beneficiary.
Member dies after age 75
From 6 April 2015, the punitive 55% tax charge that currently applies to lump sum death benefits paid from drawdown arrangements and uncrystallised rights that have been deferred beyond age 75, will initially be reduced to a flat rate tax charge of 45%; and
Any death benefits paid as an income to a beneficiary will continue (like now) to be taxed at the recipient’s marginal rate.
It is the Government’s intention, however, that from 2016/17, the flat rate 45% tax charge will be removed and any lump-sum payment will instead to be subject to income tax at the marginal rate(s) of the recipient.
Whilst these proposed changes are to be welcomed, beneficiaries will only pay no tax if the member (or last drawdown account holder) dies before age 75. Arguably the vast majority of people will die after age 75 so only a minority of beneficiaries will actually benefit from paying no tax on the death benefits they inherit.
It is also important to bear in mind that, where a scheme member has died prior to 6 April 2015 (and particularly where aged under 75) in certain circumstances it may be worth deferring any decisions over how the benefits are paid out until after 6 April 2015 in order to benefit from the more favourable tax treatment
The rules are complex and we would suggest you seek professional financial advice if you think you will be affected by these changes.
For further information on how these pension changes may affect you please contact us directly. This article is for information purposes and should not be construed as advice. You should contact an Independent Financial Adviser to clarify any of the issues raised. Quest Financial Solutions do no take any responsibility for actions taken as a result of reading this article.