Much Ado about relatively little

The reaction to the Chancellor of the Exchequer’s announcement of a change to the tax treatment of unused defined contribution pension savings on death appears to be disproportionate to the impact of the change. A reduction in taxes is welcome to those directly affected, particularly those grieving over the relatively early death of someone kind enough to pass on their savings. However, the rest of the taxpayer base will have to make up for this generosity given the (ongoing) Budget deficit in the UK. The cross-subsidy is relatively small given the expected cost of £150m per annum in the context of budgeted expenditure of £732bn in 2014/15 (i.e. 0.02% of expenditure).

 

The change does eliminate the tax penalty that has applied to inherited defined contribution pension savings and is welcome in this regard. The change affects defined contribution pension savers (besides those receiving annuities and/or scheme pensions – they will be covered below) as follows, as I understand it:

  • Those who die before age 75 and who have not withdrawn any of their savings – the full amount can be passed on to the nominated beneficiaries tax free as a lump sum, as before. No change for this category;
  • Those who die before age 75 and who are already withdrawing their savings – the full amount can be passed on to the nominated beneficiaries tax free as a lump sum instead of being taxed at 55% or drawn-down by dependents and taxed at the dependents’ marginal rate. This category is the big winner from the change;
  • Those who die after age 75 and who have not withdrawn any of their savings – the full amount can be passed on to the nominated beneficiaries as a lump sum and taxed at 45% (to be changed to the recipient’s marginal rate in 2016/17) rather than 55%. The amount can, alternatively, be drawn-down by the beneficiaries rather than just dependents and will be taxed at the recipients’ marginal rate. The outcomes for this category represent an improvement on the status quo but taxing the lump sum at the top marginal rate may well represent a penalty to many recipients until the 2016/17 change; and
  • Those who die after age 75 and who are already withdrawing their savings – the remaining savings can be drawn-down by nominated beneficiaries rather than only by dependents. The proceeds will be taxed at the recipients’ marginal rate, as is currently the case. The facility to take a lump sum, subject to 55% tax, has been abolished. The increased flexibility in terms of potential recipients is offset by the loss of the lump sum option in this category.

 

Those who receive the proceeds of their defined contribution pension savings via an annuity or scheme pension do not benefit from the above change. However, these savers do gain from the wider upcoming changes to the pension tax regime in that they remain eligible for tax relief on pension contributions over £10,000 per annum once they begin receiving payments from their annuity/scheme. Those who draw-down their savings have their tax relief on contributions capped at £10,000 per annum. This tax relief advantage means that all is not doom and gloom for annuity providers although the change might further discourage those under 75 from buying an annuity (at least until their 75th birthday).

 

The change has removed a hurdle that might previously have discouraged (pension) saving and is consequently welcome. The change is also supportive of a more level playing field, from a pension taxation perspective, consistent with the ‘Freedom and Choice in Pensions’ agenda. The intention to make a change to the tax treatment of defined contribution pension savings on death had previously been flagged so the action, if not its timing, was not a surprise. However, the number of headlines the change has generated feels out of kilter with the difference it is likely to make. Perhaps it was a slow news day? A Chancellor who is less than nine months away from the ballot box isn’t complaining.

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