Government to abolish 55% death tax on pensions

29th September 2014

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Following the pensions overhaul announced in the Budget earlier this year the government is now set to scrap the 55% ‘death tax’ which is charged when people pass on their retirement pot.

In his speech at the annual Conservative party conference in Birmingham today, it is expected that Chancellor George Osborne will announce that from next April, for pensioners who die aged 75 or over their beneficiaries, will only pay their marginal tax rate when they draw down the income as they would with any pension.

If the person who dies is under 75 there will be no tax to pay at all. The government anticipates that the new rules are likely to affect 320,000 people.

According to the BBC, Mr Osborne will say: “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.

“Not a promise for the next Conservative government – but put in place by Conservatives in government now.”

Beneficiaries of these ‘pension bequests’ will be free to draw on these bequeathed funds as soon as they receive them, even if they are under age 55: they will simply be liable to income tax on the withdrawals.

Barnett Waddingham senior consultant Malcolm McLean believes the move is extremely good news and expects it will be widely welcomed. He said: “The present rules have never made much sense hitting all people past 75 and most others under that age who have already accessed their funds perhaps by taking part or all of the tax free lump sum and/or having started an income drawdown plan.

“It is right and proper that savers can feel assured that money they have voluntarily put away in a pension plan over many years and which they have not fully used should pass on to their loved ones on their death without some exorbitant tax charge being levied on it by the government.”

However Hargreaves Lansdown head of pensions research Tom McPhail believes the changes will be a mixed blessing. He said: “They 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.”

As a result McPhail anticipates the new rules are likely to significantly boost demand for income drawdown, where savers stay partially invested in retirement, and to diminish the relative attraction of annuities, where retirees swap their nest-egg for a fixed-income for the rest of their life.

He added: “However managing the withdrawal of income from a pension fund over the term of retirement is not simple. Annuities carry two important advantages: they 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.

“Since the budget we have seen development work on hybrid retirement income products which use complex investment guarantees and hedging strategies. So far we have not seen anything which appears to deliver a better mix of guarantees and potential investment returns than simply splitting a retirement fund between an annuity for certainty and a drawdown for flexibility.”

Nicholas Oliver at wealth manager Brewin Dolphin agrees the changes will add further weight to the argument of making increased pension provision for retirement which he said “is desperately needed for a generation of underfunded pensioners to be”.

He added: “This measure should also make people think more closely about how they ‘drawdown’ from their accumulated funds, knowing that beneficiaries will be able to inherit their fund as a pension without any punitive taxation. With the previous tax regime, the balance of the argument led more to people de-cumulating their pensions at too fast a rate, as it was often more favourable to do this than leave the fund as a pension subject to 55% tax.

“It may also help to temper the fear of pensioners squandering their pots following the relaxation of the ‘drawdown’ rules in the recent budget as their beneficiaries now stand to gain more on the pensioner’s death.”

In this year’s Budget, Osborne revamped the UK’s pensions system by declaring that from April next year, savers will be able to do as they see fit with their pension pot from aged 55, and they will not be ultimately forced to buy an annuity anymore.

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