A-Day changes to pensions and the announcement of a punitive rate of tax on residual funds in drawdown beyond age 75 are likely to force a rethink on the best strategy for drawing benefits from a small self-administered scheme or a self-invested personal pension.
The new rules have taken a long time to be finalised but the end result is that we are now in a position where there is very little scope for funds to be passed from one member to another on death and this is likely to influence future planning and may result in benefits being drawn earlier and at a higher level than previously.
Before A-Day, many SSAS and Sipp clients undoubtedly saw their pension fund as a mechanism for passing on funds to the next generation.
In a SSAS, a retiring member would draw benefits from the fund in the knowledge that, if they and their spouse died before 75, the residual funds would be reallocated free of tax into the funds of younger members of the SSAS.
The A-Day changes made the picture look even more inviting by introducing more options including the ability to continue drawdown after 75, relaxing the rules on who could join a scheme, introducing lower minimum withdrawal limits and the ability to pay a taxfree lump sum if death occurred before 75.
The concept of group Sipps allowed the same potential benefits, with scope for reallocation from older members into younger members’ funds on death. Some providers jumped on the bandwagon with heavy marketing of these products.
The end result was that members who did not need their benefits were starting to look at a strategy which had more to do with estate planning than pension provision. Despite noises from the Government that tax might be imposed on the reallocation, the general feeling was that there was a clear set of rules in place.
The announcement that the reallocation would be subject to inheritance tax simply confirmed most people’s expectations on the rate of tax. Detailed rules were put in place on how this tax would be applied. A tax rate of 40 per cent may have poured some cold water on plans to reallocate funds but many still saw it as the way to organise their affairs. After all, the funds would grow tax-free until they were reallocated.
As with residential property in Sipps, however, the Government seems to have had second thoughts and the position has now changed with the introduction of a potential 82 per cent tax charge on any remaining funds on the death of a member and spouse beyond 75.
Tax at this level is highly punitive and the question now is why delay drawing benefits and store up funds if an 82 per cent tax charge is going to be imposed?
Some clients will still be reluctant to draw their full pension. No one likes paying 40 per cent tax on a pension which may be higher than they need. They will also be aware that drawdown could turn out to be the wrong move if they die before 75. Their fund could have been paid out tax-free if drawdown had not started but after drawdown a 35 per cent tax charge is imposed.
However, they need to be aware that this is a bet they are likely to lose. The chances of a 60-yearold in normal health dying before 75 is only around 15 per cent for a man and even less for a woman. Once they reach 75, they will find themselves with a big pension fund and limited options available to withdraw money from it.
Taking this into account, there is an argument now for drawing as much as possible as quickly as possible before 75 when the options start to run out. Tax will be paid on the pension at a rate which may be much lower than the end result if the funds were stored up.
Those who still have tax planning in mind can make lifetime gifts to children from their pension and, if this pension is surplus to their own needs, the seven-year rule does not apply. Taking the process further, the children can choose to use the funds to pay pension contributions and gain tax relief of their own, subject to the usual requirement of contributions being no greater than 100 per cent of earnings or the annual allowance, whichever is lower.
The A-Day rules in their current form still give a lot of tax benefits if correct planning is done. The position if you die before 75 without drawing benefits is very generous although you will not be around to enjoy it. For the vast majority who will live to 75, there is financial sense in drawing full benefits from the earliest sensible date, which after all is what a pension scheme is there for in the first place.
There is still hope in the industry that the high rate of tax on death after 75 can be reduced but we seem to be faced with a Government which has concerns, justified or otherwise, about potential tax abuse and is prepared to take a hard line against the risks of such abuse.
By careful planning along the lines set out above, however, clients may be able to achieve many of their objectives by taking a different route.
The correct choices will depend on personal circumstances and taking advice is essential but the days when a SSAS or Sipp member would choose to delay drawing benefits as a matter of course may be over.