How pensions help avoid tax from ‘Beyond the Grave’

While the freedom to take all your pension as cash on retirement has grabbed the headlines, the governments scrapping of the pensions death tax could have an even more dramatic effect.

The main talking point of the pension freedoms that will be implemented in April has been the ability to access savings as cash. But the removal of death taxes on pensions could have major implications for tax planning and how assets are passed on to loved ones.

What is Death Tax?

The so-called death tax is the tax levied on pension funds at death. Under the old rules a person who died before age 75 who had not used any of their pension could pass it on as a tax-free lump sum to a spouse. If it was paid out to a spouse or dependent child under the age of 23 as income it was taxed as such.

If they had touched their pension or crystallised it in pension speak then lump sums were paid minus a 55% death tax, with income taxed as income. Under the old rules, if a person died after age 75 the pension could be passed on to a spouse or dependent child under age 23 but less a 55% death charge, whether the pension was crystallised or not.

Now, if a person dies before age 75 the pension can be passed on tax free to anyone. If the person dies after age 75, the remaining pot can be passed on to anyone with a reduced 45% tax charge which in 2016 will change to the beneficiarys income tax rate.

Reorganise Retirement Savings

With the death tax reduction it make sense for retirees to use up the savings they have outside of pensions, such as those in ISAs; income from ISAs is tax-free whereas pension income is taxed, and money in ISAs is subject to inheritance tax (IHT) whereas a pension could be passed on tax free.

The changes also allow pension holders greater freedom to pass on funds to their children, not just their spouse, enabling generational tax planning. Similarly, a pension fund can be left to a spouse who can then in turn pass any remaining money onto the children. However, it would not be a surprise if a future government rolled back on this freedom, especially as children could gain access to any tax-free money straight away.

There is the question of whether it is right that a pension pot could be passed on entirely tax free? For example if you have a husband and wife and the husband dies before age 75, and the income he had been drawing before his death was taxed then his wife can take this money tax-free however, on reflection this would be less money to the government so would they go that far?


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