It’s inheritance tax planning, Jim, but not as we know it. Of course, Mr Spock was not an expert on the UK tax system but, if he had been, he may have uttered that phrase in the context of the pension changes introduced by the Coalition government. Some would argue that the amendments to the tax treatment of pension funds on death are the most significant part of the changes.
Where an individual has not bought an annuity, a defined contribution pension fund remains available to pass on to selected beneficiaries. Inheritance tax (IHT) can be avoided by making an ‘expression of wishes’ to the pension provider suggesting to whom the funds should be paid. However, under the old system there were other tax charges. These charges reflected the principle that income tax relief was given on contributions into the pension fund and therefore some tax should be payable when the fund was paid out. In some situations tax at 55% of the fund value was levied.
A new era for inheritance tax planning
The old message was not to leave money in your fund but now the message is if you can live off other assets and save your pension fund to access n later life, do so and if you if you don’t use it, there is comfort in knowing that your chosen beneficiaries will have the chance of accessing the accumulated wealth in a tax efficient way.
How do the changes work?
The changes mean there are now significant exceptions from the tax charges for benefits first paid on or after 6 April 2015.
• Anyone who dies under the age of 75 will be able to give their defined contribution pension fund to anyone completely tax free. This is subject to the condition that the fund is transferred into the names of chosen beneficiaries within two years. A beneficiary can take the fund out as a lump sum, buy an annuity or take income when required through drawdown.
• Those aged 75 or over when they die will also be able to pass their defined contribution pension fund to any beneficiary who will then be able to draw down on it as income whenever they wish. They will pay tax at their marginal rate of income tax when the income is received. The same tax position applies where a beneficiary receives an annuity payment. Beneficiaries will also have the option of receiving the fund as a lump sum payment. From 6 April 2016 the lump sum will be charged to tax at the recipient’s marginal rate of income tax.
The fund does not have to be left to just one beneficiary – it can be split among many beneficiaries and the beneficiaries are not restricted to the person’s family.
The new tax treatment does not apply to the extent that the pension fund exceeds the Lifetime Allowance (£1 million from 6 April 2016).
These changes may turn traditional IHT planning on its head for some. With a 55% tax charge on inherited pension funds and 40% on assets not in a pension fund, the message was ‘don’t leave money in your fund – take it out while you can’. Now the message is: ‘if you have other assets, live off those and save the pension fund for another day’. You may need access to the fund in later life, but if you don’t, there is comfort in knowing that your chosen beneficiaries will have the chance of accessing the accumulated wealth in a tax efficient way.