Pension Death tax due to be reduced
Pensioners will be able to leave more cash to their loved ones when they die after the government announced plans to reduce the death tax on pension pots. Currently, a charge of 55% is levied on any remaining invested pension when the pension holder dies. However in July 2014, the Treasury announced plans to reduce the levy in this year’s Autumn Statement – currently planned to take place in December 2014 as part of the pension freedom reforms.
The pension reforms are due to provide a retiree with unrestricted access to their retirement savings. This may result in millions more people choosing to enter into a drawdown arrangement, meaning their pensions will remain invested whilst withdrawing an income from it. Instead of purchasing an annuity, a retiree will either be able to withdraw cash from their pension as and when they like, keep it invested and live off the income, or use a combination of the two.
Currently, when a person uses drawdown and dies with a proportion of their pension pot still invested, they can leave directions for their remaining pot to be paid out as a lump sum to whomever they wish – but this incurs the hefty 55% tax charge on death benefits. It is anticipated however, that this may fall to 40% to bring it in-line with inheritance tax. As it stands at the moment, if the reforms go ahead next April, the government may stand to make more from pension death taxes than ever before particularly if more people choose to take their pensions as drawdown, rather than locking up their savings in an annuity. If they were to withdraw their entire pot it will be taxed as income at either the basic or higher rate.
Annuities can continue to pay out an income to a spouse after death, however this is only as an income. The remainder of the pension pot used to buy a standard annuity usually goes to the annuity provider, even if the amount paid out has not reached the amount it cost to buy.
The pension reforms will effectively see cash usually kept by insurers given back to family members and Exchequer coffers instead. Anyone planning on taking advantage of the new pension freedom rules for defined contribution pensions should please make an appointment with us for a personalised illustration. You can contact one of our professional financial advisers in the Kingsbridge Office by calling 01548 856096
Once money is taken out of a pension pot through drawdown for example, it falls outside of the death tax, so if you withdraw your whole pot in phases throughout your retirement, your beneficiaries may pay less tax when you die – unless they fall into inheritance tax. However, pensioners must be careful as money withdrawn from a pension pot may be taxed. The amount of which will be subject to a person’s income tax level and any money taken out of their pension in any tax year will be added on to their income to provide this.
So a retiree with a state and personal pension income of £25,000 would pay income tax of 20%. However if they were to withdraw another £25,000 out of their pension in a single tax year, this would push their income up to £50,000 and see the value above the higher rate tax threshold taxed at 40%. Taking benefits in phases may provide a more tax efficient approach and speaking to a professional financial adviser will help people understand the most suitable strategy for their individual circumstances, so please make an appointment with us to discuss your options in further depth.
The Financial Conduct Authority does not regulate taxation and trust advice.