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Chancellor urged to scrap 55% death benefit pension tax

The Government is under pressure to reform ‘nonsense’ tax rules that hit the pension pot of a saver aged 75 or over with a 55 per cent levy when they die.

Radical reforms announced by Chancellor George Osborne in the Budget will allow savers aged 55 or over to take their entire pension fund as cash without incurring a 55 per cent tax charge from April 2015.

The 25 per cent tax-free lump sum will still be available, with any further withdrawals taxed at the saver’s marginal rate.

The Treasury is reviewing whether to cut the amount of tax levied on pension savings when a person dies. At present, lump sum death benefits are taxed at 55 per cent for anyone aged 75 or over but are tax-free for people under 75.

The Budget documents say the Government wants to ensure tax rules remain appropriate, and add  that “a flat 55 per cent charge will be too high in many cases in the future”. 

Rowanmoor head of pensions technical services Robert Graves says policymakers should consider allowing lump sum death benefits to be paid tax-free regardless of the member’s age at death.

He says: “Clearly, the Budget has shown radical changes in pension policy can be made. If the Government is keen to review the thresholds and general operation of inheritance tax, why not allow lump sum death benefits to be paid tax-free in all situations rather than just for those who have not yet drawn any retirement benefits and happen to die before age 75?”

MoretoSipps principal John Moret says the current system is “a total nonsense” and needs to be reformed.

He says: “At the moment we have a tax lottery which depends on the point at which you die.

“At the very least we should move to a simple, single rate of tax to remove this anomaly, but it is not beyond the realms of possibility that the Treasury will go further and scrap it altogether.”

Principal Financial director Chris Daems says: “Due to the changing nature of retirement, increased life expectancy and the now increased flexibility of many people’s retirement pots it makes sense the 55 per cent tax charge on uncrystallised withdrawals for individuals over 75 on death is now withdrawn.

“Changing this legislation and removing the tax charge would continue to illustrate the Government is serious about making sure pensions continue to remain an attractive vehicle for longer-term saving.”

EXPERT VIEW: Robert Graves


The way lump sum death benefits payable from pension schemes will be taxed will be crucial in driving client behaviour and, indeed, advice. 

Creating income flexibility is all well and good but it would be beneficial to give individuals an incentive to keep money within a pension wrapper to provide income in their retirement years. 

That incentive could be the ability to pass unused pension funds on to beneficiaries in a tax-favourable manner. Previous pension policy has been against using pension arrangements for inheritance tax mitigation – hence the current rule of applying a tax charge on death benefit lump sums paid after age 75.  

If the Government is keen to review the thresholds and general operation of IHT, why not allow lump sum death benefits to be paid tax-free in all situations rather than just for those who have not yet drawn any retirement benefits and who happen to die before age 75?

Alternatively, if that is not palatable, why not give beneficiaries a choice? 

Receive the lump sum as cash in hand and it will be taxed at the marginal rate of income tax, or have it transferred tax-free into their own pension fund so they can choose to draw income as and when they wish from the age of 55.

Robert Graves is head of pensions technical services at Rowanmoor


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There are 4 comments at the moment, we would love to hear your opinion too.

  1. Julian Stevens 2nd May 2014 at 10:06 am

    I would like to see him go a step further and allow unspent funds on death to pass down tax free into PP’s for the next generation. Such a move would certainly help repair damaged public confidence in saving for their retirement and be a logical extension of removal of the annuity trap.

  2. While we’re at it, abolish IHT / Death Tax. Just change the rules so the recipient of any inheritance or gift pays tax on it as income at their marginal rate.

  3. Andrew Roberts 6th May 2014 at 10:43 am

    My earlier comment didnt seem to upload, so here it is again:

    Unfortunately having tax-free death benefits ad infinitum will not encourage people to drawdown on their pensions more quickly with the side effect of providing income tax sooner to the Exchequer, so I doubt this idea will come about. Perhaps, though, allowing pension funds to be inherited within pension fund wrappers tax-free is a runner – i.e. one generation’s unused pension funds can be used by the next generation.

  4. I’d agree that allowing funds to pass into beneficiaries pension funds free of tax would be a sensible incentive. Not convinced they should be tax free if passed on as cash – at least some tax should be reclaimed given the tax relief given on the way in…..

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