Following the pension freedoms announced in the Budget in March this year, the government is expected to announce significant further changes to the tax treatment of pensions.
These changes will make it possible for pension funds to be passed on to inheritors free of tax charges. Tom McPhail, Head of Pensions Research, Hargreaves Lansdown.
“These changes to the tax rules will be a mixed blessing. They will encourage investors to take the maximum possible advantage of their pension contribution allowances, which is certainly a good thing. Investors can build up their pension fund, secure in the knowledge that they can not only draw on their savings without restriction from age 55 but in addition, any unused savings can be passed on to their inheritors tax free on death.
It is therefore likely to significantly boost demand for income drawdown in retirement and to diminish the relative attraction of annuities. It will also encourage investors to preserve their pension funds to meet the cost of care funding. However managing the withdrawal of income from a pension fund over the term of retirement is not simple. Annuities carry two important advantages: they provide a guarantee of income for the rest of an investor’s life, however long that may be; they also allow investors to benefit from the ‘mortality cross-subsidy’, by sharing out some of the value of the pensions of those who die young, they increase the payments to those who live longer. This is an extremely efficient system.
Since the budget we have seen development work on hybrid retirement income products which use complex investment guarantees and hedging strategies. So far we have not seen anything which appears to deliver a better mix of guarantees and potential investment returns than simply splitting a retirement fund between an annuity for certainty and a drawdown for flexibility. An announcement on this issue was not expected until the Autumn statement in December. Therefore the timing and nature of the announcement may owe something to political expediency.”
Key points of the anticipated government announcement (NB all subject to confirmation)
· Pension funds in drawdown will no longer be subject to the 55 percent tax charge where lump sums are transferred within a pension on death
· Pension funds paid out after the age of 75 will no longer be subject to the 55 percent tax charge when transferred as a lump sum within a pension
· Drawdown funds can be passed to inheritors as pension assets, tax free
It was expected that the tax charge would reduce from 55 percent to 40 percent; a complete elimination of the tax charge is therefore considerably more radical than was anticipated.
