Fall in the cost of dying

Published by Ian Ward on

In the 2014 budget the Chancellor told us that he was reviewing the amount of tax which would be payable from residual pension funds on a member’s death.  The basic details of the proposed changes were announced in the Chancellor’s speech to his party conference and they will have surprised most – including us.

From April 2015, the tax treatment of remaining funds on death will depend on what the member was using the pension fund for at the time, and the member’s age:

If you die before age 75 with ‘uncrystallised’ funds (pension pots from which you have not started to draw benefits) then anything taken out of the residual pot by beneficiaries, either lump sums and/or ‘pensions’, will be tax-free.  Lump sums in these circumstances were tax-free anyway, but this represents a big change in respect of ‘pension’.  Might be better not to say too much about this to the family!

"The person receiving the pension will pay no tax on the money they withdraw from that pension, whether it is taken as a single lump sum or accessed through drawdown."

If you die before age 75 with Drawdown funds, then anything taken out of the residual pot by beneficiaries, either lump sums and/or ‘pensions’, will be tax-free, instead of the 55% tax on lump sums and income tax on pensions at present.  This is another boost for pensioners and their families, but members may want to hire bodyguards from age 74 to 75 because…

…On death post 75 with uncrystallised or Drawdown funds, both lump sums and pensions paid to beneficiaries will be taxed at the beneficiary's marginal rate of tax.

Unfortunately, there is to be no matching generosity for members with a ‘Scheme Pension’.  However, on the death of a member who is drawing Scheme Pension, a dependant may opt for the new ‘Flexi-Access Drawdown’ and we do not yet know from the Chancellor’s statement what the tax treatment of the dependant’s funds would be on their death.

There is also no change for members drawing annuities, and this change will further incline SSAS and SIPP members to shrink away from annuity purchase, even though it is the only way to guarantee retirement income.  It also seems particularly unfair on those who have already bought an annuity, sensibly with a dependant’s pension, as that dependant’s pension will be subject to income tax.

This is all good news, and rightly takes away much of the ‘cost of dying’ for members of SIPPs and SSASs.  The reduced death tax will also give members an incentive to preserve the funds in their pension scheme for later life, knowing that the tax on death is no longer punitive.  It may on the other hand be less good news for sports car dealers, as there will perhaps be fewer recently retired people lining up at their doors with recently encashed pension funds.

Members of pension schemes which allow drawdowns style of income have been champing at the bit to find out about new flexi-access to pension funds which is proposed for April 2015.  The draft legislation has now been published and the likely details are coming into focus.

Gaining access to Flexi-Access Drawdown

If you switch on your pension funds after 5 April 2015, and you elect for a ‘Drawdown’ style of pension, then there will be no limits at all on what may be drawn, other than the size of your pension fund.  Any income you draw will still be subject to tax.  The change is also seamless for members who already have ‘Flexible Drawdown’.

If you are already using Drawdown Pension as at 5 April 2015, then the new rules need you to take some action to switch to unlimited access to your fund.  You can either ask your Scheme Administrator for approval, which means you would not have to disturb the savings.  Alternatively, Flexi-Access could be engaged by simply drawing more taxable pension than the existing drawdown rules would allow using the current cap of 150% of the “market” pension.

This means that the switch to the flexible income rules will not always be completely automatic, but will require either a payment in excess of the current limits or a brief exchange of documents with your Scheme Administrator.  This latter route could be worthwhile even if you only intend to draw within current limits, as it is likely to save you the cost of ongoing regular reviews of your maximum pension.

Drawing the whole fund at once (Uncrystallised Pension Funds Lump Sum)

There is a subtle change to the rules around lump sums to enable people to draw the whole of their entitlement out of the pension scheme in one go.  This will allow you to take out the whole pot, tax-free for the first 25% (or higher with a scheme specific protected lump sum) and subject to income tax on the rest of the money.  This means that people wishing to draw their whole fund out at once will not need to go through the process of having a maximum pension set for them and then breaching the limits, it will instead be a single process.  However, there are some really important restrictions to access this approach. 

Members with Primary Protection, or Enhanced Protection with a protected pension commencement lump sum, and some others will not be eligible for this approach.  They instead would need to go through the slightly longer process of taking their tax-free lump sum and starting a capped drawdown pension, before electing for Flexi-Access Drawdown shortly afterwards to gain access to the rest of their money.  Incidentally, if you draw the whole of your fund out and the total drawn exceeds the Lifetime Allowance, the normal higher rates of tax are applied on the excess.

"If funds are drawn out of the pension scheme at an accelerated rate, members may find that their funds erode and later in life they no longer have sufficient assets to support them in later life."

Contribution Restrictions

Once Flexi-Access Drawdown is adopted, a new limit on the amount of contributions which can be made to money purchase pension arrangements appears.  This limit applies in the tax year during which flexi-access drawdown is adopted, so if a member has already contributed more than the new limit, they will be well advised to defer switching to flexi-access drawdown until the following tax year.  The new reduced contribution limit (Annual Allowance) will be £10,000 for money purchase arrangements, although members who also have defined benefit schemes will still be allowed to accrue a further £30,000 per annum in their other arrangements.  So much for one tax regime for all!

Very interesting…but is it safe?

If funds are drawn out of the pension scheme at an accelerated rate, members may find that their funds erode and later in life they no longer have sufficient assets to support them in later life.  It is important for these members to remember that they are taking very grown up decisions about their pension fund and will not be able to blame anyone else if it all goes wrong!

Given the proposed tax treatment of lump sums on death, we thing that in fact, people with significant retirement savings are unlikely to extract their whole tax-advantaged pension savings in one full swoop.  In fact, it appears that the more likely users of flexi-access drawdown to access their entire funds will be members with relatively small pension savings as a portion of their overall wealth, who will not need to fall back on the pension fund in later life.

As always, please contact your usual Barnett Waddingham consultant if you have any queries or would like more in-depth guidance.

Details on the precise workings are as usual lagging a way behind the announcement, and we are told that there will be more information in the Chancellor’s Autumn Statement.

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