Pensions Death Tax

Currently if you die before you have started to draw your pension, the value of your pension fund will not usually be subject to inheritance tax (IHT) at 40%, as it is excluded from your estate. However, there can be a 55% tax charge where your pension fund is passed to someone else under your will, especially if you die aged over 75.

From 6 April 2015 the 55% tax charge will be abolished. If you die before you reach age 75 you will be able to pass on your pension fund on death to any one you choose without a tax charge. The new owner of the pension fund will have no tax to pay when he or she makes withdrawals from the fund, whether those withdrawals are in the form of a lump sum or as income drawdown.

If you die aged 75 or more the person who receives your pension fund will pay tax at their marginal income tax rate on income drawdowns they withdraw from that fund, and there will be no restriction on the amount that person can withdraw from the fund. However, if the beneficiary of the fund wants to take all the value out as a lump sum, there will be 45% tax charge, although that may change from April 2016.

If you die after you have bought an annuity with your pension savings, the value of your pension can’t be passed on, unless the annuity contract provides for a lump sum to be paid on your death.

These changes mean that tax planning for older people needs to be re-thought from the bottom up to take into account the ability to pass on tax-free a significant pension pot. Talk to us about your options.

Pension lifetime allowance

The Government want us to save enough so we can each draw an adequate pension in retirement, but if you save too much you will be stung with a 55% tax charge when you draw your pension. The boundary between ‘enough’ and ‘too much’ savings is set in law by the lifetime allowance, which is a value of your total pension savings at retirement. This allowance will be reduced from £1.5 million to £1.25 million on 6 April 2014.

To give you an overview on these seemingly high numbers: an annual pension of £75,000 for a man aged 65 at retirement, today requires a pension fund of roughly £1.5 million. A pension fund of £1.25 million would deliver an annual pension of about £62,500 to the same person. If you contribute to a defined contribution pension scheme (the most common type), the value of your pension fund will be shown on your annual pension scheme statement.

If you are a member of a final salary pension scheme it will promise to pay you a pension equivalent to a percentage of your final salary. That could be as much as 2/3rds of your final salary. Work backwards from your current salary to get a rough idea of how much your pension fund may be worth. Your pension scheme trustees will be able to give you more accurate figures.

Once you have those figures, you can judge whether you need to elect to fix your lifetime allowance at its current level of £1.5 million, where your pension fund already exceeds £1.25 million. This is known as ‘fixed protection 2014‘, and you need to apply to HMRC to do this before 6 April 2014.

Once fixed protection 2014 is obtained you won’t be able to make any further pension contributions to a registered pension scheme. If you are a member of an occupational pension scheme which receives automatic contributions on your behalf, you will have to opt out of that scheme or lose the fixed protection.

After 6 April 2014 there will be another way of protecting your pension fund, called ‘individual protection 2014‘. This will fix your lifetime allowance at the value of your pension rights as at 6 April 2014, up to a maximum of £1.5 million. You should discuss with your financial adviser which type of pension protection is best for you.