At the Conservative Party conference this week, George Osborne announced the end of the 55 per cent death tax on pensions. This turns financial planning completely on its head. Under the current regime it makes sense to spend pension assets in drawdown as ultimately they would be subject to a 55 per cent tax charge on death after age 75, as opposed to inheritance tax on non-pension assets at 40 per cent. However, now there is a real incentive for people to leave their money inside their pension, instead drawing down on assets outside of their pensions in order to leave more to their families.
From 6 April 2015, both lump sum and pension death benefits paid following the death of a pension saver before their 75th birthday will be completely free of income or inheritance tax. If the date of death is after the saver's 75th birthday, pension benefits will be subject to tax at the recipient's marginal rate of income tax. Lump-sum death benefits paid from 6 April 2015 to 5 April 2016 will be subject to tax at 45 per cent, and from 6 April 2016 will be taxed at the marginal rate of tax of the recipient.
So much change has been introduced to the pensions rules this year, which runs entirely contrary to decades of traditional UK pensions thinking, that many will find it hard to get their head around the new pensions landscape. The old pensions system would see insurance companies pocketing the unused funds of most pension savers. Now their families can benefit instead. Your home may still suffer inheritance tax, but your pension passes on tax free to the next generation. So make sure all your pension funds have been notified of who you would like to benefit.
The move has further undermined the appeal of annuities compared with income drawdown and will potentially lead to high levels of transfers out of final salary schemes into self-invested personal pensions (Sipps).
In many final salary schemes, the income generally ceases on the death of the member and their spouse. The option of transferring valuable benefits into a Sipp in order to pass on a share of a pension fund to children may prove attractive, although will not be for everyone.
The timing of the chancellor's announcement does feel like it has been arranged for political gain rather than carefully thought-out policy. An announcement on the pensions death tax was not expected until the Autumn Statement in December. Many technical details around the rule change have yet to be clarified.
Investors should note that the general election on 7 May 2015 is only six weeks after the start of these new rules. With pensions firmly established as a political football, no rule change is absolutely guaranteed.
The end of the death tax will not make the main problem of sustaining an income for decades of retirement any easier. There is plenty of development work going on in the pensions industry for hybrid retirement income products which use complex investment guarantees and hedging strategies. But splitting a retirement fund between an annuity for certainty after age 75 (to guarantee a minimum income, for example) and drawdown for investment and income flexibility still looks the best option.
