The Government announced a shake-up of defined contribution (DC) pensions in March’s Budget and at the time said it would consult on the 55% tax rate applying on some undrawn pension funds at death.
"Alongside the new flexibilities, this is a welcome announcement. We do need to wait for final legislation, but this freedom will further encourage pension savings. We recommend, as always, that individuals should take specialist advice in relation to pensions as the legislation is constantly changing."
Following the announcement by the Chancellor on 29 September, we finally have some clarity from HMRC on the removal of the 55% tax on pensions at death. HM Treasury and HMRC plan to discuss the technical detail further with industry stakeholders prior to final legislation.
Death after age 75
Currently an individual can pass their DC pension to their dependant (spouse, civil partner, child under 23 or other financial dependant), who can then draw it down at their marginal rate.
The new rules mean that if a person dies after age 75, any beneficiary will only pay their marginal rate of income tax if they designate the funds to a drawdown account and take it as a drawdown benefit. There will be no limit on the amount that can be taken under drawdown. If a drawdown account is not set up, any lump sum taken would be subject to a flat tax charge of 45%. This will be taxed at marginal rate from 2016/17.
Death before age 75
If a person dies before age 75, there will be no tax whether or not the pension fund was in drawdown at date of death (subject to any uncrystallised defined contribution being within the deceased individual’s available lifetime allowance) and any beneficiary can take it as a lump sum or designate it to a drawdown account. This is currently tax free only if the pension fund was not in drawdown (i.e. was uncrystallised) and within the deceased individual’s available lifetime allowance.
Below is a summary of the current and the expected new rules from 6 April 2015:
|Current rules||Crystallised funds||Uncrystallised funds|
Below age 75
|55% charge if paid as a lump sum or dependants can draw at their marginal rate of tax||Can pass on as a lump sum completely tax free to any beneficiary up to the deceased’s lifetime allowance|
Above age 75
|55% charge if paid as lump sum or dependants can draw down at their marginal rate of tax||55% charge if paid as lump sum or dependants can draw down at their marginal rate of tax|
|New rules||Crystallised funds||Uncrystallised funds|
Below age 75
|Can pass on completely free of tax to any beneficiary as a lump sum or a drawdown benefit||Can pass on completely tax free as a lump sum to any beneficiary (up to the lifetime allowance)|
Above age 75
|Any beneficiary can draw down on it at their marginal rate or 45% charge if paid as a lump sum (marginal rate from 2016-17)||Any beneficiary can draw down on it at their marginal rate or 45% charge if paid as a lump sum (marginal rate from 2016-17)|
The inherited DC funds do not impact the beneficiary’s lifetime allowance.
Subject to scheme rules, the new rules will apply similarly to defined benefit (DB) pensions. The only difference being where the deceased has dies before age 75 and a beneficiary receives a scheme pension. In this case the pension will be taxed at the beneficiary’s marginal rate.
The new measures will come into force from 6 April 2015, at the same time as a series of other significant changes to DC pensions announced in the Budget. It will apply to payments from 6 April 2015 and so beneficiaries of anyone who dies before that date can still benefit as long as payment is delayed until after that date.