The new death benefit rules that come into play from 6 April are far more generous than anyone anticipated when the Chancellor first announced in last year’s Budget that he would look at the 55 per cent charge.
Not only has the rate of tax dropped significantly but pretty much anyone can be a beneficiary and use the fund to provide an income. This becomes a really attractive, tax-efficient way of passing funds down the generations, particularly if the deceased was over 75, in which case tax is payable on the pension at the recipient’s marginal rate.
When funds are retained in a pension, rather than being paid out in a lump sum, all the tax advantages can be retained: limited tax on investment income, no capital gains tax, no inheritance tax.
If funds have been passed on to basic-rate taxpayers, the withdrawals can be managed to avoid breaching the higher-rate threshold. If the recipients are non-taxpayers they can take out money tax free up to their personal allowance each year. With the ability to pass on again any residual funds and unrestricted access whenever required there really are few reasons to withdraw funds until you need to spend them.
All of this is fantastic news – but the changes may not be as automatic as some would have you believe.
The legislation sets out very specific rules about the circumstances in which the scheme administrator can nominate a beneficiary to receive an income.
There is no question of the administrator’s discretion being removed (and therefore no implications for IHT) – subject to scheme rules, the administrator can always choose to designate benefits to any beneficiary, whether nominated by the member or not. But if the beneficiary is not dependent and not nominated, they may only be able to receive the benefits as a lump sum. The flexi-access drawdown option would only be available if the scheme member has not nominated anyone else and has no dependants.
A case that illustrates the implications of this is that of a Mr Williams, who died aged 85. His wife predeceased him and he had nominated his only child, John, to receive his benefits.
John is 55 and a higher-rate taxpayer, so he would pay at least 40 per cent tax on any benefits he took as income (or 45 per cent if he took the fund as a lump sum). John has two children, aged 18 and 20, who are at university and have no income.
John does not need the income and would rather the fund was used to provide income to support his children while they are at university and starting their careers. This would be a more tax-efficient use of the money as they could receive the first £10,600 each year tax free (2015/16 threshold) and pay basic rate tax on any further income up to the higher-rate threshold.
Even though all parties are in agreement and John believes his father would have supported the change, if the scheme administrator uses its discretion to pay to the grandchildren they can only receive the benefits as a lump sum, not as a pension.
The fact that this money can only be paid out as a lump sum means it will be taxed at 45 per cent if paid in 2015/16 and, assuming lump sums are taxed at marginal rates after this, it will be much more difficult to manage the tax liabilities than using a pension.
The moral of this story is: make sure your clients’ beneficiary nominations are up-to-date. With such significant rule changes coming into play, a conversation should be had to ensure the current nominations really do meet your clients’ objectives.
It is also crucial that nominations are reviewed when circumstances change. In addition to reviewing nominations following a death or divorce, it may now be appropriate to review how benefits are distributed after the birth of a grandchild or great-grandchild.
For clients concerned about passing funds on in a tax-efficient manner, reaching the age of 75 is an obvious point when nominations may need to be changed. So, get your nominations in.
Mike Morrison is head of platform marketing at AJ Bell