BLOG: How the end of the ‘death tax’ will affect you
From April next year, anyone inheriting pension assets will be able to receive them tax-free if the pension holder died before age 75 or, if older, the beneficiary will be taxed on withdrawals at their own marginal tax rate.
Abolishing this punitive tax is welcome news. Most people agree it’s a deeply unfair that the lion’s share of a deceased’s hard-earned pension savings will go to the Tax Man instead of a dependent child or surviving spouse.
The interesting twist to this recent change, however, is the removal of any distinction between beneficiaries with regards to the tax position. In other words, whether you nominate your wife to receive your pension after death or Bob from down the road the tax position appears to be the same.
Opportunities arise to pass pension assets to the next generation without suffering 55 per cent tax or being factored into an Estate for Inheritance Tax purposes. This is particularly attractive for a single person, widow or widower looking to bequeath pension benefits after their own death.
There are rules around when you can start drawing an income from your own pension. In most cases, you won’t be able to do so until age 55 at the earliest.
A minimum age doesn’t apply when accessing an inherited pension, however. In theory, from April, thousands of much younger people could gain access to a tax-free lump sum or a pension account they can make withdrawals from.
Where grandchildren have been nominated to receive the account, children and even babies may be able to receive a pension income.
Students could be given a real leg-up, for example. Inheriting a pension from a grandparent of, say, £50,000 would provide an income at university over three years as well as a deposit for a property on graduation. Assuming the individual has no other income whilst studying, they could withdraw £10,500 a year from the pension account without exceeding their personal allowance for income tax. In other words, even if the grandparent was over 74 on death, the income could be received tax-free.
At the same time these pension changes are announced, a number of housing market analysts are pointing to a downturn, brought on by the combination of three major factors: the introduction of tighter mortgage application rules earlier this year, expectations of an interest rate rise in the next few months and a whole generation of would-be first time buyers struggling to pay rents, let alone save for a deposit.
Redistributing wealth from pensioners to 20 and 30-somethings over the next few years might be considered one way to prevent a market crash.
Of course, not everyone will be able to take advantage of these changes. It’s important to be clear about which types of pension the Chancellor is talking about.
Anyone drawing an income from an annuity or final salary pension is not affected by these changes.
An annuity can either be arranged on a single-life basis or a joint life basis. An income will only be paid out to a surviving spouse or civil partner if a joint life annuity is purchased. If a guarantee period, such as five years, was selected on buying the annuity, payments will continue to the end of the guarantee period if death occurs within it. Otherwise, the annuity provider keeps any remaining pension fund.
A final salary pension will normally pay a reduced pension to a surviving spouse or civil partner (or a dependent child under the age of 23, if still in full-time education). After that, the money is gone. The new rules do make it more attractive for anyone who has not yet started to draw their final salary pension to consider a transfer into a personal pension in order to pass on up to 100 per cent of the remaining pension assets after death instead of the income to
The type of pension that is affected by these changes is a ‘drawdown’ pension. This is an account wherein the pension assets are invested throughout retirement and an income is ‘drawn down’ from the invested fund. On death of the pension holder, there may well be some invested funds still left in the account – and it is these that can be passed to a nominated beneficiary.
Currently, drawdown is only really suitable for people with pension savings in excess of £100,000. Those with lower pension values were typically forced into buying an annuity instead. From April next year, however, all restrictions on drawing a pension income will be removed, allowing everyone (who has the right to access their pensions) to draw as much income as they like from their pensions – up to 100 per cent in one go if they like.
Lauren Peters is a pensions adviser at Tideway Wealth.