6th May 2014 at 2:27pm
How do you feel about a 55% rate of tax applying to your pension pot, when it’s passed on to your
I think it’s unfair, risks driving the wrong outcomes for customers and is part of a complex system which is ready for review.
The Government signalled change ahead for the 55% tax charge as part of the Budget Day pension changes in March. In its consultation paper Freedom and Choice in Pensions, it acknowledges that the 55% tax charge can be too high in many cases.
When does the 55% tax charge apply?
This tax charge applies in two situations where a lump sum is paid out, most commonly with a SIPP:
- Where a person dies aged 75+, it applies to the whole fund, regardless of whether someone has taken any withdrawals from their pension yet or not.
- Where a person dies before the age of 75, and had started to take withdrawals (eg is in income drawdown/has taken tax free cash), it applies to the part of the pension which has been ‘touched’, known as “the crystallised fund”.
I would like to see a simpler and fairer result for people and their loved ones. I believe this can be achieved by aligning the death benefit tax charge to the inheritance tax regime in the two situations above. Here’s why :
- In our model, the tax outcome depends on the amounts involved, so it’s not a flat rate. I believe this is fairer. It is fairer because the tax charge is reduced from 55%, to either 40% or 0% in line with IHT. As usual with inheritance tax, whether tax is due will depend on the identity of the recipient and the overall wealth of the individual.
As usual with inheritance tax, whether tax is due will depend on the identity of the recipient and the overall wealth of the individual.Money which passes to a spouse, civil partner or charity will be exempt from tax. And money which passes to other recipients may have 40% inheritance tax deducted if the overall value of an individual’s estate (including the value of the pension) exceeds the inheritance tax threshold, which is normally £325,000. This context creates a fairer outcome as those with smaller estates and pensions are less likely to have a tax charge under our model.
- A charge of 55% risks driving the wrong customer outcomes and acts as a penalty for those who ‘do the right thing’ and take a sustainable income from their pension pot. Alignment with IHT takes the tax sting out of that sensible decision.
- It avoids the more complex route of applying an income tax charge to the beneficiary, when that might create the need for a tax return to be filed by someone who does not normally complete a tax return under the self-assessment rules. Aligning the position with inheritance tax instead means all the paperwork and payment is dealt with as part of the estate administration process. This process already involves HMRC forms relating to pensions and could be adapted more easily to accommodate the new regime.
- The age of 75 should not be a trigger-point for tax, and would be removed in this proposed solution for the new regime.
- In terms of “uncrystallised funds” (ie. pensions which have not been touched yet), as now, the death benefit lump sum should remain tax-free.
How to have more control over who benefits from your pension
In our proposal, the value of the pension fund would be aggregated with the estate in the situations describe above. But who receives the pension fund is still something that would be managed by the pension provider with reference to any
Naming a beneficiary for your pension is something you can do with a form which is easy to change and keep up-to-date as family circumstances evolve. Expression of Wish form left by the customer. This creates more flexible results, especially for the many people who don’t put a Will in place. Naming a beneficiary for your pension is something you can do with a form which is easy to change and keep up-to-date as family circumstances evolve. You can request a form from your pension provider.
The Consultation to shape the new pension rules for April 2015 is underway. This is a great opportunity to make the tax rules simpler and fairer for millions of people whose pensions could now be affected by this tax point. In the past, if your pension decision was focused on buying an annuity, this tax issue was not relevant for you. Now that new choices open up after April 2015, this tax rate could apply to many more people than before, which is why it needs fixed.
What do you think of the 55% tax rate? We’d like to hear from you – post your comments below.
You can now subscribe to regular MoneyPlus blog updates too by simply entering your email address in the subscription bar at the top right-hand corner of the site.
This blog and any responses to comments should not be regarded as financial advice.
A SIPP is an investment. Its value can go up and down and it may be worth less than you paid in.
Laws and tax rules may change. Information based on our understanding in May 2014. Personal circumstances can also impact on tax treatment.