Dramatic changes to the way in which people can draw their pension benefits took effect from April this year. Brought in under the Government’s ‘Pension Freedom’ initiative, the new rules are designed to give control and choice to owners of personal or money purchase pensions.
The prior restriction of an annual cap on pension withdrawals has been replaced with unlimited access to your pension fund after age 55, subject of course to income tax once you have exhausted the first 25% which remains tax free. Careful planning is advised to ensure that your future financial security is not compromised by exercising this freedom. The new rules, however, have much wider ramifications than just making sure your pension lasts. A number of other changes, including remodeling the taxation of pension death benefits, are now causing many people to rethink not only their pension planning but their entire retirement strategy.
The main pension changes have been well publicised. With the new freedoms come restrictions to contribution levels for high earners and for those who start drawing benefits under the new flexible rules. The Lifetime Allowance will reduce to £1m from April 2016; tax charges will apply to pension benefits valued in excess of this lifetime cap although those affected may qualify for transitional protection.
Annuity options have widened with the ability to choose a guaranteed payment period in excess of the previous 10 year limit; potentially giving more back to beneficiaries when someone dies in the early years after retirement.
Small pension pots valued under £10,000 enjoy special status and subject to certain rules can be cashed without triggering restrictions to your future contributions and without counting towards the Lifetime Allowance.
Pension death benefits
One major change with perhaps the farthest reaching consequences is to the taxation and shape of pension death benefits. Gone is the previous 55% tax charge on income drawdown pots. Instead, any pension fund whether in drawdown or as yet ‘uncrystallised’ can pass to your chosen beneficiaries tax-free up to the Lifetime Allowance if you die before age 75.
For those who die after age 75 the charge is reduced to 45% until April 2016 after which it will be removed and pensions can pass as a lump sum taxed at the beneficiary’s rate of income tax. As before, surviving spouses and civil partners will also have the options of annuity purchase or income drawdown. A crucial change is that now any chosen beneficiary can ‘inherit’ your pension plan and draw benefits at a time of their choosing; effectively introducing a new form of successive pension ownership.
Where a successor is to inherit the pension fund even death after age 75 will not in most cases trigger a tax charge. Only when the successor chooses to withdraw money from the pension could an income tax charge apply the level of which is dependent on their personal taxable income. This opens new possibilities for planning especially where beneficiaries are able to make use of their personal allowances and basic rate tax band.
For those with a potential inheritance tax liability the changes mean that their pension fund could be the most tax efficient asset to pass to their beneficiaries.
Nominating pension death benefits to a trust remains attractive for many people, especially where leaving a lump sum to a surviving spouse is likely to increase an eventual inheritance tax charge. In most cases this will only be beneficial where the pension owner dies before age 75 which means that trust arrangements should always be reviewed prior to reaching a 75th birthday.
There is still scope for inheritance tax and lifetime allowance charges to apply to pension death benefits in some circumstances and advice should always be sought before making changes to your plans. Existing beneficiary nominations should be reviewed and care should be taken as not all pension administrators will be able to facilitate all the options under the new rules.
The new pension regime opens new possibilities which can benefit individuals and family members of all ages. A fresh assessment should be made as to how pensions and other savings can be structured to best provide for retirement, for dependents and where appropriate for the next generation.
By Iain Andrews, Director and Chartered Financial Planner
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