We appreciate that customers can find these things confusing; therefore we won’t discuss the current pre-April 2015 rules. The simple thing is to say that the new rules are far more generous to customers than the old ones.
These rules apply to any customer who has a pension fund (not necessarily a pension income) in their name. Those customers affected will be those with a pension plan where they are saving for retirement, someone in income drawdown, and temporary annuities where death benefits have been selected and there is a maturity lump sum payable. In fact anybody who has a personal pension fund in their name, whether they are contributing or not, are likely to benefit from this change.
People who are not likely to be affected are those in final salary pension schemes, as the scheme is more than likely to have its own death benefits built in, and those who have purchased an annuity. In the case of an annuity the pension fund was given away to an insurance company in exchange for an income for life, therefore unless the annuity pays a lump sum on death (most don’t) there is no pension fund to pass on.
The new rules are very simple and are based on your age on death – in particular if you are older or younger than 75.
In the case of a pension fund holder who dies before the age of 75, then no matter who they leave their pension fund to, the person(s) receiving the fund can take it all as a lump sum with no deductions for tax whatsoever. This is a major change.
It is also worth remembering that pension funds are outside of standard inheritance tax calculations. Unlike your home, other property and investments, your pension fund does not form part of your estate for inheritance tax purposes. This means that a person with a pension pot of say £1 million who dies before the age of 75 will pass that fund TAX FREE to their spouse, children or beneficiaries.
Pension fund holders who die aged 75 or older will have some tax to pay.
For the first year of these new rules, up to 5th April 2016, there will be a flat rate tax of 45% payable on inherited pension pots. This is a 10% saving on the current rate.
From 6th April 2016 onwards, then the amount of tax payable will depend on the tax rate of the person(s) receiving the inherited pension pot. Based on current tax rates this could be as low as 20%. The inherited pension pot will be treated as income; therefore it will be added to the recipient’s annual income and taxed accordingly. As an example, a 20% tax payer may have to pay tax at 40% if the pension pot takes them into this tax threshold, and likewise it could also push them into 45% tax. This is known as being taxed at your marginal rate. However as 45% is the current highest rate of tax in the UK then this is the highest amount of tax that can ever be paid on any inherited pension pot. Again this is at least a 10% saving on the current rate.
Obviously tax rates could change for the better or worse in the future.