This year has seen massive changes to pension rules. The latest changes affect the so-called death tax that is applied to many peoples’ pension pots when they die.
In this video I look at these most recent changes and how they will affect the likes of you and me.
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Hi. You've probably heard a lot about the ‘death tax’ or the death charge recently. So, I thought I'll take a look and explain how the rules have changed on this front.
It's all about people who have saved money into their pension pots through their working lives – they now have a defined contribution pension pot. If they then die, the question is, will their descendants have to pay any tax on that pension pot when they inherit the money?
The point is, George Osborne has recently announced changes to the rules, which means you're more likely not to pay any tax, your descendants are more likely not to pay any tax, or at least a lower rate of tax.
Let's explain the rules now as they stand at the moment. You’ve saved into your pension pot and you die before you were 75. If you've got an untouched lump sum pension pot – you've not taken a pound out from your pot, you've not bought an annuity – if it's completely untouched and you die before you're 75, then you can pass that lump sum onto your descendants, tax free. That's the only really good bit of the rules as they stand.
But if you've already put your lump sum into income drawdown, (so you're already beginning to take an income from that pension pot), then when you die, any remaining money in the pension pot is passed onto your descendants after a 55% death charge has been levied.
Of course, if you've used your pension pot to buy an annuity, in most cases, that means all the money is gone anyway when you die. It's possible you might have bought an annuity with a guaranteed period, so your spouse or someone else might receive an income for a few years after your death. If that's the case, whoever is going to receive that annuity income after you die will just pay that income at their marginal rate of income tax.
So, that's the current rules if you die before you're 75.
If you die after you're 75, if you’ve got a lump sum in your pension pot, even if it's untouched or if you've already started income drawdown (it doesn't matter either way), your descendants will have to pay a 55% death charge before they get access to that lump sum. The rules, I just outlined for an annuity, are exactly the same as they were for a death pre-75.
Now let's look at how the rules have changed and how they have improved for the better. If you die before you're 75, if you have a lump sum in your pension pot – and it doesn't matter if it's an untouched lump sum or if it's already started going into drawdown – either way, that can be passed tax-free onto your descendants. That's fantastic for pre-75.
If you die post-75 and if your descendants want to take all the money now, they can take it as a lump sum, but they will have to pay a 45% death charge. So, that’s lower than it was before, but still pretty high. But your descendants might decide not to take all the money as a lump sum and instead take an income just in dribs and drabs over many years in the future.
If they do that, they will pay income tax, their marginal rate of income tax, which may well be a lot lower than 45%. I think this is what's really got people excited about these new death tax rules. With the new rules coming in from next April, pension pots won't be liable for inheritance tax.
So, that means you can leave money in a pension pot that's tax protected, it can carry on growing and be invested in the stock market, not run up any tax liability, then you can hand on this sort of multigenerational trust fund to your descendants.
They only have to pay income tax, at their marginal rate of income tax when they withdraw money from this ‘pension trust fund’, if you like. It’s completely protected from inheritance tax and people are only paying income tax when they take money out. So, that's very, very nice.
I can see why people are quite excited about these news rules which are starting next April. And when you combine them with all the other changes that George Osborne has made to the pension system this year, there's no doubt that saving into a pension has become a lot more attractive relatively compared to Isas (individual savings accounts).
A year ago, I think there was a strong argument for saying that Isas were definitely better and more attractive than pensions for saving for your retirement, with a few exceptions. Now, pensions are relatively more attractive. That's because you've got more flexibility and you're probably going to end up paying less tax than was previously the case.
The other point to bear in mind also with pensions, is when you pay the money in, you get tax relief, and then when you pull it out, you can pull 25% out and not pay any tax on that tax-free lump sum, which is up to 25% of your pension pot.
So, with pensions, now you've got increased flexibility and an ability to pay even less tax than you would with an Isa. And so, the only real drawbacks for a pension now are that you still can't pull the money out until you're 55. There's also the danger that future governments might change the rules again so that pensions become less attractive as a savings vehicle.
But as far as I am concerned, I'm probably going to save more money into my pension in future and less money into Isas, and I think it will be a good idea for everyone to at least consider taking that view.
The best news is that many people are now going to avoid the death tax, or if not that, at least pay the death charge at a lower rate.
That's great news for all of us.