THE PENSION TAX AND GRANDCHILDREN

There has been talks in the UK press about a recent decision by the government to abolish the "Death Tax". Unfortunately this is not Inheritance Tax (IHT) which continues to be taxed at 40% of estate assets of more that £325,000 (£650,000 for couples) and includes the family home.

Instead this is a tax on private sector (Defined Contribution) pension funds that have not been spent at the time of death. The technicalities are complex (and boring) so we will spare you and only summarise them in the table below. If you do want more information, details are available across the UK press and of course will be available on HMRC's website.


 

What is it?

This really relates to only a small number of people (320,000) and the sums are also small when considered across the UK, however we think it is something that could be very interesting to the average person.

Private pensions allow you to put your pre tax income into an investment fund and draw out later, at a potentially lower tax rate, when no longer working. Pension funds are not counted in IHT calculations, but assets were otherwise caught by HMRC and taxed at an extortionate rate of 55% at death.

From April 2015 this tax is being scrapped in most cases (see table below), which will provide an incentive to keep money within a pension fund, where can accumulate tax free until required. This is particularly beneficial given the increasing longevity society is experiencing.

 

Why is this relevant?

Under the proposed changes, the remaining assets of the pension fund can be transferred to anyone upon death and free from IHT and Death Tax. This will allow grandparents to efficiently pass on money to children, grand children or anyone else, depending on what is the most efficient and suitableThis change should make pensions a much more attractive means of not only accumulating money but also passing it on to younger generations.

The pension fund wrapper allows pre tax money to be invested with the tax deferred - a 20% return on 100% is better than a 20% return of 60%. As the tax sting has now been taken out, this is a way of either deferring or even eliminating tax and planning wealth transfer across multiple generations.

Money will now be taxed at the marginal rate of the beneficiary when taken. Remember that children have the same income tax thresholds as adults (see here for more information), so are able to receive £10,000 tax free.

Prior to this change grandparents would have to try and keep excess money out of pension funds if they didn't expect to spend it. If their total assets were likely to be in excess of the IHT threshold, they would need to gift the money away and hope to outlive the 7 year look-back period.

 

The bad news

Residential property still cannot be held in pension funds, despite everyones wishes. In our view this is not a bad thing as it would only worsen the affordability issue our society is experiencing. However this issue does still demonstrate how out of touch the IHT thresholds are given the appreciation we have seen in the average family home over the past few decades..., but thats a topic for another discussion.

There are also limits on the amount that can be contributed to pension funds in a given year and also a lifetime cap that you should be aware of. If these are an issue you should also be aware that these have been decreasing in recent years and we would not be surprised to see these continue to decrease as an easy tax on the more affluent.

 

  

Outgoing System

  Death Before 75 Death After 75
Money is kept within the Pension Fund wrapper    
- No Money has been withdrawn from the Pension Fund Tax free Tax @ 55%
- Money has been withdrawn from the Pension Fund (eg in income drawdown) Tax @ 55% Tax @ 55%
Money is withdrawn from the Pension Fund wrapper Taxed at marginal rate Tax @ 55%

The incoming System

  Death Before 75 Death After 75
Money is kept within the Pension Fund wrapper    
- No Money has been withdrawn from the Pension Fund Tax free Tax free
- Money has been withdrawn from the Pension Fund (eg in income drawdown) Tax free Tax free
Money is withdrawn from the Pension Fund wrapper Tax free Taxed at marginal rate

HootLoot are not tax advisers and we do not offer tax advice. If this is something that is of interest we recommend that you speak to a professional adviser.

 

 

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