Changes to Taxation of Pension Death Benefits - case studies


On Monday 29th September 2014, the Chancellor of the Exchequer announced far reaching changes to pension death benefits, which are great news for pension savers. Pensions can now cascade down the generations, skipping generations if desired, and avoid the previous draconian pension tax charge of 55%. To help you understand how these changes might affect you, we have put together a few case studies. These represent our best understanding of how the new rules will work, but until legislation is published, we won’t know for sure. So, please bear this in mind when you are reading the case studies.

If you have any queries about your personal situation please talk to a financial adviser.

Case study 1 - John

Background

John is 65 and has been using phased pension withdrawals for the last 3 years. He has so far only taken tax-free lump sums of £25,000 and £10,000 from the crystallised part of his pension. Today, he has a crystallised pension fund of £70,000 and an uncrystallised pot of £120,000.

Old rules

If John died under the old rules, as he is under age 75, the £120,000 would be paid out tax-free to his beneficiaries and outside of his estate for inheritance tax.

The £70,000 in John's crystallised fund could be paid to his beneficiaries outside the pension, but subject to a tax charge of £38,500 (55% of the remaining fund).

Alternatively, John's spouse or dependants could use his pension fund to buy a dependant’s income drawdown product or an annuity.  The income or annuity payments would be taxed at his spouse's or dependants' marginal rate of income tax.

New rules where benefits are paid on or after 6 April 2015

If John died under the new rules, the whole £190,000 could be paid out tax-free to his beneficiaries and outside of his estate for inheritance tax.

Alternatively, John could nominate anyone to inherit his pension fund and the recipient could draw income from that fund or, if a spouse or dependant, buy an annuity. The income drawn from the fund would be tax free.  Annuity payments would be taxed at the recipient's marginal rate of income tax.

Case study 2 - Jane

Background 

Jane is aged 76 and has a defined benefit pension in payment for the past 11 years of £5,000 a year. She also has an income drawdown pot of £85,000 from which she has already taken tax-free cash and she is also making annual withdrawals of £4,000.

Old rules

If Jane dies, and is survived by a spouse and/or dependants then her defined benefit scheme may pay a spouse's or dependant’s pension, if the pension scheme rules provide for survivor benefits. Should a spouse's or dependant’s pension be payable it will be taxed at the spouse's or dependant’s marginal rate.

The £85,000 in Jane's drawdown pot could be paid to her beneficiaries outside the pension, but subject to a tax charge of £46,750 (55% of the remaining fund).

Alternatively, Jane's spouse or dependants could use her pension fund to buy a dependant’s income drawdown product or an annuity.  The income or annuity payments would be taxed at her spouse's or dependant’s marginal rate of income tax.

If Jane did not have a spouse or any dependants, a further option would be for her to bequeath the remaining drawdown pot to charity, which could be passed on to her chosen charity without deduction of any tax.

New rules where benefits are paid on or after 6 April 2015

If Jane dies, and is survived by a spouse and/or dependants then her defined benefit scheme may pay a spouse's or dependant’s pension, if the pension scheme rules provide for survivor benefits. Should a spouse's or dependant’s pension be payable it will be taxed at the spouse's or dependant’s marginal rate.

The £85,000 in Jane's drawdown pot could be paid to her beneficiaries outside the pension, but subject to a tax charge of £38,250 (45% of the remaining fund). The Government intend the tax charge to be at the recipient’s marginal rate for payments made from 6 April 2016.

Alternatively, Jane could nominate anyone to inherit her pension fund and the recipient could draw income from that fund or, if a spouse or dependant, buy an annuity. The income or annuity payments would be taxed at the recipient's marginal rate of income tax.

If Jane did not have a spouse or any dependants a further option would be for her to bequeath the remaining drawdown pot to charity, which could be passed on to her chosen charity without deduction of any tax.

Case study 3 - Tom

Background

Tom is 79 years old and has a personal pension worth £60,000 that he has never got around to drawing on as he is still working.

Old rules

If Tom dies, the £60,000 in his personal pension could be paid to his beneficiaries outside the pension, but subject to a tax charge of £33,000 (55% of the remaining fund).

Alternatively, Tom's spouse or dependants could use his pension fund to buy a dependant’s income drawdown product or an annuity.  The income or annuity payments would be taxed at his spouse's or dependant’s marginal rate of income tax. 

If Tom did not have a spouse or any dependants, a further option would be for him to bequeath the money in his personal pension to charity, which could be passed on to his chosen charity without deduction of any tax. 

New rules where benefits are paid on or after 6 April 2015

If Tom dies, the £60,000 in Tom's personal pension could be paid to his beneficiaries outside the pension, but subject to a tax charge of £27,000 (45% of the remaining fund).  The Government intend the tax charge to be at the recipient’s marginal rate for payments made from 6 April 2016.

Alternatively, Tom could nominate anyone to inherit his pension fund and the recipient could draw income from that fund or, if a spouse or dependant, buy an annuity the income or annuity payments would be taxed at the recipient's marginal rate of income tax.

If Tom did not have a spouse or any dependants a further option would be for him to bequeath the money in his personal pension to charity, which could be passed on to his chosen charity without deduction of any tax.

Case study 4 - Margaret

Background

Margaret is aged 67 and bought a 'value protected' annuity at age 60. A value protected annuity can pay a death benefit equal to the amount used to purchase the annuity minus the instalments received to date of death. The original purchase price was £100,000 and Margaret has so far received 7 annual instalments of £5,000 each.

Old rules

If Margaret died at age 67, £65,000 (i.e. the original purchase price of £100,000 less the £35,000 of instalments paid to Margaret to her date of death) can be paid to her beneficiaries less a 55% tax charge of £35,750.

New rules where benefits are paid on or after 6 April 2015

If Margaret died at age 67, £65,000 (i.e. the original purchase price of £100,000 less the £35,000 of instalments paid to Margaret to her date of death) can be paid her beneficiaries tax-free, as she is under age 75 when she died.

 

This information is based on Aviva's interpretation of current law and legislation, HM Revenue & Customs' (HMRC) practice and the changes announced by HM Treasury on 29 September 2014.   It is provided for general information purposes only.  Aviva take no responsibility for any decisions or actions taken as a result of the information given and should not be relied upon in place of legal or other professional advice.  You should always seek appropriate professional assistance where formal advice is required.


AR01307  10/2014

Back to top