By Neville Pereira, Financial Services Director,
Lubbock Fine Wealth Management LLP
The Government’s announcement on the relaxation of pension rules following the Conservative Party conference has changed the investment landscape. With higher rate tax relief, tax free growth, a tax free lump sum and an inheritance tax free asset, pension is now, arguably, the most tax efficient investment of all. In addition, after the age of 55, pension holders will be able to treat their pension pot more like a bank account.
Consequently, with the current period of political uncertainty and the proposed new rules, this may be a last opportunity to benefit from tax relief at an individual’s highest marginal rates, as both the Labour Party and Liberal Democrats have alluded to the withdrawal of higher rate tax relief. Therefore, maximising pension payments in the immediate future is strongly recommended.
The new rules will come into effect in April 2015 and the main changes are:
- the removal of income limits from defined contribution schemes;
- a reduced annual allowance for those using new flexibilities;
- a reduction in the tax charge on lump sum death benefits where the member was in
- drawdown or over 75 years of age;
- a ban on transfers from unfunded defined benefit to defined contribution schemes.
From 6 April 2015, retirement income limits will be removed for defined contribution (DC) pensions. Members of pension age can take what they want from their DC pension pot, when they want it. Notably, unlike the current rules for flexible drawdown, there won't be a ‘minimum income requirement'.
Under the current rules, what happens to a pension upon death is complex and ultimately depends on the age of the deceased and whether they have taken any money from their pension.
If no money is taken from a pension – namely the pension is uncrystallised – then a 55% tax charge will be payable only on the lump sum paid out to beneficiaries if the deceased is over the age of 75. However, if the deceased is under the age of 75 then a lump sum can be paid out tax-free.
There is another option for passing on a pension; the pension is paid out as income rather than as a lump sum. However, this option is limited to passing the regular pension income on only to those people that meet the rather restrictive pension definition of ‘dependent’. This definition means only a spouse or children under the age of 23 will likely qualify for this income and, additionally, they will have to pay income tax on it.
So what’s changing?
Death pre aged 75
Under the new pension rules from April 2015, if you die before the age of 75, the pension can be passed to anyone regardless of whether they are a dependent. This pension can be taken via a lump sum or via income and is completely free of tax. Unlike the old rules, it doesn’t matter ifthe pension is touched. Regardless of whether the income or lump sum taken is from the pension pot, it is passed on tax-free, as long as the person who died was aged under 75.
Death post aged 75
Unfortunately, the tax charge on a pension if the pensioner dies after the age of 75 has not been abolished, but the rate at which a lump sum is passed on is currently in transition. From April 2015, if a person dies aged 75+ and their pension is passed on to their beneficiaries as a lump sum, it will be liable to a 45% tax charge. However, by 2016, the government intends to make lump sum payments subject to tax at the beneficiary’s rate (known as the marginal rate) rather than the current 45% flat rate. This means there is an opportunity to control the tax point and for some people this could mean a zero tax rate. As before, if beneficiaries want to take the deceased’s pension as an income, not a lump sum, the income paid out will still be taxed at their income tax rate.
These new rules only apply to ‘defined contribution’ (DC) pensions, also known as ‘money purchase’ schemes, which are the most widely held in the UK. Defined benefit (DB), or ‘final salary’ schemes as they’re also known, have separate rules. There is an existing ban on transfers once benefits are in payment, and this will continue. Members of unfunded public sector DB schemes won't be able to transfer to DC schemes.
Pre-retirement members of funded defined benefit (DB) pension schemes will be allowed to transfer to defined contribution (DC) schemes to access the new income flexibility. It will be advisable to seek advice before deciding whether or not to take advantage of the new pension rules.
Will my family pay inheritance tax (IHT)?
On death, a pension falls outside the deceased’s estate and is not subject to a 40% inheritance tax (IHT). However, if a person uses the new pension freedom to withdraw their entire pension pot and puts the money into a bank account or otherinvestment, then the money is considered to be savings and will become part of an estate for IHT purposes.
New restrictions on contributing limits to private pension Pension contributions will remain subject to a £40,000 annual allowance limit, with the ability to carry forward unused relief from the previous three years. With clever planning, potentially up to five years' annual allowance can be paid in order to benefit from higher rate relief. However, after April 2015, any income withdrawals from a defined contribution pension, in addition to any tax-free cash already withdrawn will restrict contributions
There are three exceptions:
a) If a pension is worth £10,000 or less it can be taken as a ‘small pot’.
b) Those going into capped drawdown before April 2015, and withdrawals after that, remain within the current drawdown limit, even if moving more funds into the same plan.
c) When a pension is taken as a lifetime annuity (other than a flexible annuity) or a scheme pension (except when fewer than 12 people are entitled to one under that scheme).
This £10,000 limit does not apply to any benefits building up in a final salary pension. Investors already in flexible drawdown before April 2015 will be able to make contributions of up to £10,000 per annum (they are not currently allowed to make any contributions).
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This article is for information only and professional advice should be taken in advance of any changes to your financial affairs. HM Revenue & Customs’ practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen. Tax advice and National Savings & Investments are not regulated by the Financial Conduct Authority. Lubbock Fine Wealth Management LLP is an appointed representative of Financial Ltd, which is authorised and regulated by the Financial Conduct Authority.