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Lack of planning could lead to an unexpected 55% death tax on pension savings

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A worrying level of people in retirement are not using their pension savings efficiently, says a report by Skandia.

According to the report, this could result in pension funds being hit by an unexpected 55% tax charge on death. This tax could be avoided or reduced in many cases.

The data highlights that 59% of customers in capped drawdown are not taking an income, these are customers who have taken their maximum tax-free cash lump sum, and then left the rest of their pension fund invested.

The remaining pension fund is technically in ‘drawdown’, even though they are not taking an income, which means the remaining pension fund is subject to a 55% tax charge if paid as a lump sum to a beneficiary on the member’s death.

Adrian Walker, Skandia’s pension expert, comments: “The number of people currently in drawdown and not taking an income highlights just how many people could benefit from further financial planning.

“We believe our statistics will be mirrored by a large extent across the industry, showing just how many people could be at risk of suffering a 55% tax charge on death.

“The current economic climate is probably exacerbating the situation as people may be delaying taking an income until gilt yields and stock markets improve, as this could help secure them a higher income level.

“Delaying income could be part of someone’s long term financial plan, but if someone is unaware of the implications their actions have, on death, their beneficiaries could be faced with an unexpected 55% tax charge on part of those savings.”

For those who die below age 75, this tax charge was increased from 35% to 55% in April 2011, so many people may still be unaware of it.

The 55% tax charge is a substantial figure, and people should seek financial advice to see how best to mitigate this tax liability.

However, Skandia point out that leaving money inside the 55% taxed environment may not always be a bad thing, especially when taking into account income tax and inheritance tax implications if it is moved to within their estate.

Skandia also advises consumers to consider the following key points:

Under age 75:

• It is only money held in ‘drawdown’ which is potentially subject to a 55% tax charge on death under age 75, untouched pension funds can be left to beneficiaries without any tax charge.

• Consumers could consider phasing the amount they move into drawdown, using tax free cash to provide part of their immediate income needs.

• Also consider taking an income from the remaining money in drawdown. If they do not need the income, they could reinvest it back into a pension as a contribution.

• Contributions will benefit from tax relief, and the pension fund built from those contributions will not be deemed in ‘drawdown’, so will not be subject to a 55% tax charge on the member’s death before age 75.

• Flexible drawdown can be used to enable money to be moved out of the 55% taxed environment at a much quicker rate than capped drawdown.

• To qualify for flexible drawdown a person must be receiving at least £20,000 guaranteed pension income a year, they then have unrestricted access to the remaining pension fund.

Age 75 onwards:

• All money left in a pension is subject to a 55% tax charge on death, regardless of whether the funds are in ‘drawdown’ or not.

• People should consider accessing as much of their pension fund as possible to move money outside of this 55% tax charged environment.

• Flexible drawdown can again be used to move money out of the 55% taxed environment at a quicker speed than capped drawdown allows.

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