The 55% tax charge on inherited pensions will be abolished from April 2015, the Chancellor George Osborne has announced.
Inherited defined contribution (DC) pensions that have a drawdown arrangement or have not been accessed will face new tax treatment depending on the age of the owner on death.
Death after 75 – the beneficiary pays income tax on the pension at their marginal rate. Funds can be accessed in any way including a lump sum option which will be taxed at 45%.
Death before 75 – DC pension pots can be passed on tax-free, whether it is in a drawdown account or untouched (provided it is taken as lump sums or taken via a flexible drawdown arrangement).
The new rules will not apply to annuities or scheme pension.
DC pensions that are already being taken as drawdown are taxed at 55%, regardless of the owner’s age when they die.
Untouched DC pension pots face a 55% tax charge if the individual is over 75 when they die.
Untouched DC pensions pots where the owner dies under the age of 75 can be passed on as a tax-free lump sum up to the lifetime allowance (£1.25 million for the 2014/15 tax year).
The news has been generally welcomed by the pensions industry and business groups.
Dr Yvonne Braun, head of savings, retirement and social care at the Association of British Insurers, said:
“A 55% tax charge if someone dies before they have accessed their pension fund goes against the grain of the wider government policy of making pension saving more popular by giving people more options on how to use their retirement savings. This is a sensible move which deserves support.”
John Cridland, director general of the Confederation of British Industry, welcomed the changes but urged the government to do more to encourage retirement saving:
“There is a real issue in the UK with people not saving enough for retirement, especially as we are now enjoying longer lives. The government should also commit to keeping the higher rate of tax relief on pensions, as we try to rebuild our savings culture.”
Andrew Tully, pensions technical director at MGM Advantage, said savers should not assume they will be able to pass on their pension tax-free:
“On the face of it these changes are good news for savers with defined contribution pensions and creates great headlines. But the reality is that the vast majority of people retiring with good health should expect to live beyond age 75. So the chances of people passing on tax-free lump sums are slim.”