George Osborne chose to detonate yet another pensions policy bomb at the Conservative Party conference this week. The last time the Chancellor stood up and spoke about pensions he unleashed the most radical reforms for almost a hundred years.
The latest announcement – that “death tax” charges on pensions are to be cut from April – is another example of the Government springing policy on an industry already reeling from unprecedented changes.
The reforms, which will come into effect from April next year, will see the 55 per cent penalty on inherited defined contribution pensions when a member dies before age 75 scrapped for drawdown arrangements.
However, this is not the case for most annuities and scheme pensions, meaning the Government is explicitly favouring drawdown over annuities through the tax system.
With insurers’ share prices plummeting once again on the back of the announcement, has Osborne hammered the final nail into the coffin of the annuity?
Industry insiders have privately rebuked policymakers for the manner in which the death tax announcement was made. At the weekend, national newspapers were briefed that the 55 per cent charge on pensions passed on after a member’s death would be scrapped in Osborne’s keynote conference speech. However, as further details were published, it became clear the truth was more complicated.
The Government previously signalled the death charge would be brought into line with inheritance tax, currently 40 per cent, and this was expected to be part of the Autumn Statement. But the unexpectedly early announcement – propelled by negative headlines surrounding Tory MPs Brooks Newmark and Mark Reckless – created confusion as the Treasury appeared to give conflicting information to leading industry figures.
Currently, DC pensions in payment are taxed at 55 per cent if the member dies before the age of 75. Under the new rules this charge will be abolished completely for pensions in drawdown arrangements.
The Treasury has since told Money Marketing that value protected annuities – where policyholders pay a premium to ensure any remaining annuity payments are passed on if they die – will also benefit from the tax cut. However, this clarification did not come in time to stop the share prices of specialist insurers Just Retirement and Partnership falling sharply on the announcement.
Osborne further added to the confusion by saying the changes took effect “from today”, while the Treasury announcement said the new rules would apply to all payments made after April 2015.
The Treasury subsequently confirmed the Chancellor meant that beneficiaries could “benefit from today” as long as they waited until April to take the pension, even if the member died before then.
Liberty Sipp director John Fox says: “Even the most charitable observer couldn’t fail to find the timing a touch fishy. The announcement had been due to remain under wraps until December, but after the Tories’ tempestuous weekend, the Chancellor has clearly decided to generate some positive headlines.”
Death of the annuity?
Providers and industry experts were broadly supportive of the change, saying people had been given a new incentive to save into pensions. But there are concerns the Government’s agenda is unfairly promoting drawdown at the expense of annuities, which could lead to savers running out of money in retirement.
James Hay head of technical support Neil MacGillivray says: “The winners will be those platforms which offer flexible drawdown solutions. But it is a further nail in the annuity coffin, which is regrettable.”
Hargreaves Lansdown head of pensions research Tom McPhail agrees. “If that’s the proposition, why would I buy an annuity when I get to retirement age?
“I looked at this and came away thinking I can’t see where the annuity market is going to go from here.”
But LV= Retirement Solutions managing director John Perks says: “This shouldn’t affect people’s buying decisions because drawdown and annuities are fundamentally different products.
“The Government is trying to bring to life more flexibilities and drawdown is more flexible, so it follows that they will benefit more.”
Perks adds that 92 per cent of fixed-term annuities sold by the insurer have value protection, which will also benefit from the tax cut.
Partnership head of product development Mark Stopard says: “There is a lot of negative sentiment being directed toward annuities. Our research shows that people want a guaranteed income for life, and the only way to do that is through an annuity.
“It would be a real shame if customers who can’t afford to take the risk associated with drawdown go into those arrangements and run out of money before they die. There’s a real risk of poverty in later retirement and they’ll leave nothing to pass on.”
Transferred not abolished
Experts say the Government’s pledge to “abolish” the death tax on pensions is not all it seems.
Savers will only pay no tax if they die before the age of 75. Pension pots inherited when a member dies over age 75 will still be subject to tax.
In this case, beneficiaries will pay a flat rate of 45 per cent, as opposed to 55 per cent currently, if they take the bequeathed pension as a lump sum or at their marginal rate if they draw it down as a pension. The Government says it will consult on making both types of withdrawal taxable at marginal rates by 2016/17.
Adviser support company Adviser Advocate chief executive Richard Leeson says: “On a like-for-like comparison before this announcement and after – for the majority of people who die after the age of 75 – then rather than having a tax charge of 55 per cent against them, it’s a 45 per cent charge against the beneficiaries.
“Rather than abolishing the tax, there’s been a transfer of who pays the tax, and a small reduction.”
MGM Advantage pensions technical director Andrew Tully agrees. “You have to bear in mind that the vast majority of people will die after 75. So only a few people will pay no tax. It’s a neat political move and because it’s quite complex you can already see that the mainstream media has gone for the simple message.”
Aviva head of pensions policy John Lawson argues the majority of savers will not benefit from the reforms.
“For most people it’s not going to touch them,” he says. “Most people will need to use their pension pots for their own needs, including long-term care.”
But McPhail says the changes could bring some clear advantages. “The beneficiaries could take a year off work, not take any income, and pull a chunk of money out of the pension pot. Critically, you are only going to pay tax on it when the money’s drawn out. The next generation has a tax-free pot of money they can draw on at will.”
However, the Government is yet to publish further details, including at what age beneficiaries, who could be young children, will be able to draw on the income.
It also remains unclear whether funds that have already been crystallised – and so subject to the current 55 per cent charge – will be reimbursed in light of the announcements.
AJ Bell chief executive Andy Bell says: “While I welcome the spirit of these changes it does feel like an area where a short consultation with the industry would have avoided potential problems that will come from the application of the new rules.
“The Government has put pensions at the centre of its pre-election giveaway. What is concerning is that pensions have once again become a political football. In some ways the new rules look too good to be true and I have to question whether they would survive the first Budget of a Labour Government.”
Labour’s position remains unclear. Shadow chief secretary to the Treasury Chris Leslie says: “Pensioners are paying more in tax because of George Osborne’s VAT rise and the so-called ‘granny tax’ which abolished the age-related tax allowance for the over- 65s.”
The Government’s decision to retain the age of 75 as a hard cut-off point for tax treatment has also been questioned.
Barnett Waddingham senior consultant Malcolm McLean says: “In an ideal world all tax charges on pension funds inherited on death would be abolished without a distinction between those aged under and over 75, or at least would only apply where the death occurred at a later age than 75.”
Boost to advisers
Pensions could be set to receive an influx of funds as wealthier savers move assets away from areas subject to inheritance tax in favour of the newly protected pensions environment, experts say. Aegon regulatory strategy manager Kate Smith says the tax cut is “fantastic” and “another string to the bow of financial advisers”.
She says: “That’s the whole story around the new pension flexibilities, it’s so important people use advisers. For a lot of people, normal behaviour would be to empty your pot before dying but now they might want to ring-fence funds to pay for long-term care, or set some aside for children and grandchildren.”
Aviva’s Lawson agrees. “There are some key tax advantages here because it would appear the pension is the most efficient way of passing money on. For instance, pensions are a much more attractive place to leave your money than buy-to-let properties. It might encourage people to reconsider where they hold their assets in the future. That really plays to financial planners’ strengths.”
As the Government seeks to further incentivise saving into DC pensions, fears are growing that members of defined benefit schemes may be encouraged to transfer out of their existing, generous arrangements.
PwC pensions partner Peter MacDonald says: “This will make transfers from DB to DC more appealing for those with ill health and for those who see their pension more as part of their family wealth.
“A DB pension of £10k can translate to a DC pot of £200k, so being able to protect and pass on this significant sum on death will be appealing, especially for those without a spouse who would usually have nothing to pass on from a DB scheme.”
Policy announcements are subject at times to a political timetable and it is not always possible to divorce decision making from the short-term political climate. Sometimes the industry has to pick up the pieces of that agenda but it would be naïve to think that wouldn’t be the case.
That said, the way this was briefed to the industry and the media was incompetent and ineptly managed. Even on Monday the Treasury did not know what they were talking about and policy people were giving conflicting briefings. That is extremely unfortunate and was clearly linked to the Chancellor deciding to rush the announcement out for his conference speech.
That said, I quite like the way this Government has cracked on with things. There are risks to making policy decisions so fast and without extensive consultation, but the pensions system needed a sense of purpose and vision and the Government has shown that.
I’m perplexed by the decision to deliberately weight the tax system away from guaranteed incomes. In fact, the Treasury is creating a system that appears to incentivise transfers out of DB schemes, so there is a collective push away from guaranteed benefits and towards risk-based benefits.
That element of the decision making doesn’t entirely make sense to me, but the overall thrust of individual ownership, personal responsibility and engagement is hugely positive and should encourage people to save more. The idea of being able to pass on your pension to the next generation is an attractive one to investors.
However, this all needs to be paid for and policymakers have potentially created a system that is less efficient in sharing out mortality cross subsidies.
This is a huge headache for any retirement accumulation provider, whether it is an occupational scheme, an insurance company or a platform. It is now virtually impossible to adequately serve your existing customers if you don’t offer them a complete menu of retirement solutions, including drawdown, annuities, advice and guidance.
Tom McPhail is head of pensions research at Hargreaves Lansdown
What has happened?
Defined contribution pensions in payment will be passed on tax free from April 2015 if the member dies before the age of 75. Previously only untouched pensions were exempt from the 55 per cent charge. However, pensions inherited from a member who dies after 75 will be taxed at the beneficiary’s marginal rate of income tax if taken as a pension, or 45 per cent if withdrawn as cash. Value protected annuities will be subject to the same rules, but standard annuities and scheme pensions will not.
Minesh Patel, managing director, EA Financial Solutions
Advisers should be running their hands with glee, there are more opportunities for retirement planning and lifestyle planning, and people now don’t have to worry they can’t get their money out in life, or in death.
Ray Tammam, IFA, Fairstone Financial Management
This makes pensions even more attractive. There is now very little reason for people not to contribute and I think people will move assets into pensions. But it’s a very big risk moving from DB schemes and if there’s an avalanche of people wanting to do that there may be legislation brought in to stop it, because people are giving up valuable guarantees.