Pensions – All change again

 In Finance & Investments

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55% income tax on death

The biggest change – and one very relevant to private client practitioners – has been an increase in the tax rate, from 35% to 55%, for pension funds in payment via drawdown.

The coalition government has now confirmed, to a large degree, how pensions are likely to work – for at least the next couple of years anyway!

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55% income tax on death

The biggest change – and one very relevant to private client practitioners – has been an increase in the tax rate, from 35% to 55%, for pension funds in payment via drawdown. This is the tax charge on death for those pensions that have been crystallised, and so the benefits have commenced, but have not been used to buy an annuity.

This has had the effect of making drawdown slightly less attractive, and, by contrast, annuitisation slightly more attractive. This is significant because on death a client’s pension fund is treated very differently from those assets held in the estate.

The new 55% rate is a significant increase. However, private client practitioners should be aware that this tax charge need not apply if the deceased had nominated a dependant or had nominated a charity.

Therefore, the opportunity for significant planning exists for this onerous tax rate.

Flexible Drawdown

A further change that has been confirmed is that once an individual has total pension income of £20,000 per annum they are now allowed to withdraw all of their pension fund as a taxable lump sum. This is a further way of avoiding the 55% tax charge on death though please note that the lump sum taken from the pension (after, of course, the 25% tax free lump sum) is taxable at the members marginal rate of income tax in that year.

As a result, for those exercising this option there is likely to be an income tax charge followed by a potential inheritance tax charge on death after extracting the fund from the pension.

Again, careful planning is required.

Pensions are for retirement income

Let us not forget that the reason pensions obtain such generous income tax relief in the first place, on contributions as well as on ongoing capital growth, is because they were intended to provide a retirement income for the individual and/or their dependants.

Some might say that it is a generous option that all of the fund can be left tax free to a charity; and that there has become a significant increase in the flexibility and planning available for pension funds. Practitioners should point out that pensions are not assets which were ever intended to be passed to the next generation. At least not with all of the tax exempt status still attached.

Never an annuity?

One increased flexibility that has been confirmed is that from age 75 an individual does not need to buy an annuity (though this remains an option.). Instead an individual can maintain drawdown indefinitely and so can now at least pass on 45% of the remaining fund to non-dependants on death. This had not been available prior to 6 April, 2011. In fact, prior to 6 April, 2006 an individual had to buy an annuity at 75. Therefore, the options have improved greatly in recent years.

Annuities have been much maligned. However, they do allow a certain and known income to be generated from an otherwise potentially highly taxed asset on death. For instance, a male annuity at age 75 can generate approximately 10% income for life. An income of this size from a fund that is otherwise likely to be taxed very highly, can allow more planning freedom to be exercised with assets in the estate and which at worst would only be taxed at 40% – not 55%.

There are many options now, different tax rates to compare, as well as different income yield rates. This area requires careful planning from an adviser that understands the different options, prevailing yields, and tax rates.

In the past the options were more straightforward, now more than ever good tax and financial advice are required.

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