Pension death tax reprieve reactions – praise, concerns and dilemmas

The abolition of the current 55 per cent tax on pension funds on death has received a broad welcome although some concerns have been expressed at new dilemmas raised by the move.

The tax cut, which goes much further than the pensions industry had expected, is expected to encourage more people to use up their full pensions contribution allowance and keep their assets within their pension for longer.

Under the changes, which come in from next April, pension assets passing on death after age 75 will pass tax-free if kept within a pension, or subject to heirs’ marginal tax rate if drawn.

On death before age 75, currently a 55 per cent tax charge is levied if benefits have been drawn. Under the new rules, this charge will disappear and no tax at all is payable, even if heirs draw assets from the fund.

The Treasury believes the new rules will deter some people from spending all their pension too soon, and also lead to people saving more in pensions, for longer. The move is predicted to further reduce the attractiveness of annuities to savers.

But some experts have pointed out that the freedom to pass on benefits in a tax-efficient way through DC arrangements creates a new dilemma for those in DB schemes who will feel a pressure to leave a bequest to their heirs.

Broadstone pension director Simon Nicol says: “Members of generous final salary pension schemes approaching retirement now face a massive dilemma. Do they stay in their final salary scheme and enjoy their secure pension for life, but deny their children and grandchildren any benefit should they die earlier in retirement? Or do they transfer into a defined contribution pension savings account, which could provide their extended family with huge financial benefit – but which could leave them short of income if they live too long?”

Association of Consulting Actuaries chairman David Fairs says: “The reforms that both the Treasury and DWP are implementing are on the whole very welcome in offering new flexibilities to both employers and employees, but the time-frames that we are working under, with so many details of these policies remaining unresolved, is extremely worrying.

“My big fear is that both employers and even more so pension providers and advisers are simply going to be overwhelmed in the current months ahead, with the danger that consumers will become frustrated by industry’s inability to deliver the promised flexibilities.  Many of the changes require significant systems changes and my fear is that mistakes will be made in the rush to implement.

“Pension taxation, in particular, needs to be genuinely simplified.  This requires a pause in the ‘permanent revolution’ so we can reflect and cut through the complexity in regulations and uncertainties which are mounting almost on a day by day basis.”

NAPF chief executive Joanne Segars says: “Today’s announcement is an eye-catching addition that is a natural follow on to the freedom and choice initiative mapped out by the Chancellor in his March 2014 Budget. While it may encourage some people to save more into their pension, assured they will be able to pass on the lion’s share without tax, the reality is that this is likely to affect only people with larger pension pots.  

“What will affect millions of people is the Guidance Service which they will need to help them make good decisions when planning their retirement income. Beyond today’s announcement the focus must be on making sure the Guidance Service is in place ahead of these changes coming into force next year. The proof of all these reforms will be in their implementation and how they affect savers and voters. With less than 140 working days until the service must be up and running, the clock is ticking.

“The Government also needs to keep hold of its promises about the annuity market, which the majority of savers are likely to still depend on for some of their retirement income. They should accelerate the review of the annuity market to ensure it is working well and can provide savers with products that offer good value.”

Dr Ros Altmann, the government’s older person champion says: “Under the existing rules, anyone who dies over age 75 can only pass on their pension fund tax free to a spouse or dependent under 23 years of age, but passing on to older children or grandchildren attracts a draconian 55 per cent tax charge. In future, all inherited pension funds will be free of tax if they are kept as pension savings. If their heirs then take money out of the fund, they will just pay income tax at their marginal rate, which is far lower than the current 55 per cent of course.

“Only the wealthiest can usually afford not to touch their pension before age 75, so this is good news for ordinary savers, who often will not be able to afford to leave their pension funds untouched until age 75. The existing rules disproportionately benefitted the wealthiest, but now every pension saver, regardless of their means, will know that their hard-earned savings can pass on to their loved ones without the current unfair tax penalty.”

    Die before age 75Old system Die after age 75Old system Die before age 75New system Die after age 75New system

Pension fund passed on (as a pension) if no money yet withdrawn

Tax free

55% tax

Tax free

Tax free

Pension fund passed on (as a pension) if tax free cash taken or in drawdown

55% tax

55% tax

Tax free

Tax free

Tax payable if funds passed on are spent rather than kept in a pension

Marginal/income tax

55% tax

Tax free for anyone

Income tax