ADVISER FACTSHEET

Tech Talk October 2014

‘Death’ of Pension Death Tax The Chancellor’s Party Conference announcement on the subject of death benefits for pension schemes further confounded our expectations in the ‘staid’ world of pension tax legislation. There is little in the way of information or guidance from the Treasury on the proposals and therefore this Tech Talk is more akin to an ‘opinion’ piece than a detailed technical piece.

Contents

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For professional advisers only

Overview Death benefits – current position Death benefits – proposals Comment

Overview Once again the industry has taken a sharp intake of breath, and posed the question, “has the Chancellor really just said that?”. As with his Budget Speech, the Chancellor has stunned us all with the announcement at the Party Conference that from 6 April 2015, there will be no tax charge on the payment of certain death benefits from a money purchase arrangement where the member is under 75 at the time of their death. In addition, for death after age 75, ultimately the recipient of the fund will only pay tax at their own marginal rate of income tax. The special lump sum death benefit charge (SLSDBC) of 55% will therefore disappear.

Normally, before we produce a technical bulletin we would at least wait for the appropriate draft legislation, however, due to the number of telephone calls we have received seeking clarification on the Chancellor’s announcement, we thought it pertinent to provide some information on the matter. It should be noted that there is little in the way of official comment/information from the Treasury on these proposals, and what little there is, in a number of instances, is ambiguous. As a result, the following views may differ significantly from the final version of the legislation, and therefore it would not seem appropriate to put any real emphasis on these, particularly when you discuss the proposals with your clients.

Death benefits – current position Where a member dies before the age of 75, the tax treatment of pension rights depends on a number of factors including whether the rights are crystallised or uncrystallised. In the case of a dependant(s), they can choose to be paid a lump sum death benefit, a dependant’s pension or a combination of both. If there is no dependant, then the beneficiary(ies) can only have the lump sum. This, along with whether the fund is crystallised or not, will have differing affects on the tax treatment of the benefits.

their marginal rate on the income withdrawals. There is no benefit crystallisation event associated with a dependant’s pension and therefore the excess is not subject to an LTA charge at that point. However, on the death of the dependant, and presuming there are no further dependants, the payment of a lump sum death benefit from the residual fund will be subject to the SLSDBC at a rate of 55%. It is possible to have the residual fund paid as a charity lump sum death benefit; in which case there will be no SLSDBC applied.

In the case of an uncrystallised fund, the lump sum can be paid out free of tax up to the member’s lifetime allowance (LTA) limit. Any amount in excess of this will be subject to the LTA charge at 55%. An alternative for a dependant is to designate the fund as a dependant’s drawdown fund, where any income taken will be subject to the dependant’s marginal rate of income tax. In a situation where the member’s rights exceed the LTA, it may be possible for the dependant to take any uncrystallised rights up to the LTA as a lump sum, and then designate the excess as a dependant’s drawdown fund, paying income tax at

The tax treatment of the pension rights vary where the member is under age 75 at the time of their death and has crystallised funds. In such a scenario, if the rights are paid as a crystallised lump sum death benefit then they will be subject to the SLSDBC. The alternative is for the dependant to take a dependant’s pension, which will result in their marginal rate of income tax being applied to any income withdrawals. If the dependant elected for a drawdown pension, then as mentioned previously, the payment of a lump sum on the death of the dependant will be subject to the SLSDBC.

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If the member is over the age of 75 when they die, then whether the rights are uncrystallised or not has no bearing on the tax treatment of a lump sum death benefit. Either way, the lump sum will be liable to the SLSDBC charge at 55%. As before, a dependant could elect to take a dependant’s pension rather than the lump sum and pay tax at their marginal rate on the income. On their death, the SLSDBC would apply if the residual fund is paid out as a lump sum.

Dependants may have the option of choosing an annuity or scheme pension rather than electing for a dependant’s drawdown. However, unless there is any term certain guarantee or annuity protection lump sum death benefit, there would be no further tax liability on the death of the dependant as the annuity/scheme pension would end on their death.

Death benefits – proposals According to the proposals, if the member is under age 75 when they die, they will be able to pass on their defined contribution pension fund to any beneficiary free of tax, subject to the LTA limit where the pension rights are uncrystallised. Other than the LTA, it is implied there will be no difference in the tax treatment between crystallised and uncrystallised rights; thus if the beneficiary elects to take the lump sum from the member’s crystallised fund, unlike at present where the 55% tax charge will apply, the fund will be paid free of any tax. If they so choose, the beneficiary could opt for a “pension beneficiary drawdown account” from either crystallised or uncrystallised funds. Either way, any drawings from this “account” will be free of income tax where the member died before age 75. This will not apply in the case of income from an annuity or scheme pension; any income from these sources will be taxed at the dependant’s marginal rate. There is no mention on any tax implications if there is a residual “pension beneficiary drawdown account” fund left on the death of the beneficiary. Should a beneficiary choose this option, the investment growth in the fund will continue tax free as per a normal drawdown fund, regardless of whether the original member was over or under 75 at the time of their death and whether their fund was crystallised or uncrystallised.

Where the member is over age 75 when they die, if the beneficiary opts for the lump sum, a tax charge at 45% will be applied whether the fund is crystallised or not. The Treasury intends to consult on this with the possibility that from the 2016/17 tax year the applicable tax rate will be at the beneficiary’s marginal rate rather than the flat rate of 45%. If the beneficiary elects instead to take an income from a drawdown account, they will pay tax at their own marginal rate. Although the proposed changes will generally apply to defined contribution (DC) pensions, there are a number of other lump sum death benefits that will be covered under the reforms. As with DC lump sum death benefits, they will also be tax free where the member dies under age 75, and taxed as above when the member was over 75. To clarify, the following five lump sums will benefit from the change: 1. pension protection lump sum death benefit 2. annuity protection lump sum death benefit 3. drawdown pension fund lump sum death benefit 4. defined benefits lump sum death benefit 5. uncrystallised funds lump sum death benefit In a situation where the member died before 6 April 2015, it is suggested that the reforms can still apply as long as payment of the death benefits is made on or after 6 April 2015. Therefore, in principle, the beneficiary could ask the scheme administrator to delay the payment in order to benefit from the changes.

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EXAMPLE 1 Joan, a widow, died on 1 August 2013 aged 67. She left a crystallised pension fund now valued at £800,000. However, because one of the assets was a commercial property that was difficult to sell, the scheme administrator has not yet paid out the death benefits. The sale of the property should conclude in the near future. As a result of the proposed reforms, Joan’s only child, John, has asked the scheme administrator to delay payment of a lump sum until 6 April 2015. This should be paid free of any tax, whereas if he were to take the lump sum when the sale completed there would be an SLSDBC of £440,000, with the balance of £360,000 going to John.

On the death of the member, the benefits will be tested against their LTA, if this has not previously occurred. The announcements are silent on the scenario where a member has fully crystallised their fund, and subsequently died before age 75 but due to investment growth their fund value exceeds the LTA. Under present rules the payment of a drawdown pension fund lump sum would incur a tax charge of 55% (the SLSDBC) and therefore this growth would be taxed. It is presumed that the actual legislation will factor this in, otherwise a member could crystallise up to their LTA, take no income, and if they were to die before 75, the compounded growth would pass to the beneficiaries without any tax liability. The pension fund the beneficiary receives will not count towards their own LTA.

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Comment Transformational change for pensions seems to be a common theme at the moment, and the potential opportunities afforded by the latest announcement could be significant. However, it should be remembered that apart from the Chancellor’s speech and a release from the Treasury there is little in the way of detail on which to base any technical opinion. We all know with pension tax legislation the devil is in the detail, which in turn usually creates the complexity, and the final legislation could differ in many ways from the initial announcements. As a result, this Tech Talk is somewhat light from a technical perspective; however, we felt the announcement merited at least some comment.

One final point to make, which may slightly dampen the initial euphoria, is that of life expectancy. According to the Office for National Statistics, in 2012, the average life expectancy for a male aged 65 was approximately 83, and for a female 86. Thus, a significant proportion of people will survive beyond 75 and so tax will still apply to many inherited pension funds.

Further information Visit the Technical Hub for further information: Ian Linden Technical Manager Pensions

www.jameshay.co.uk/technicalhub

Please note that every care has been taken to ensure that the information provided in this article is correct and in accordance with our understanding of current law and HM Revenue & Customs practice. You should note however, that James Hay Partnership cannot take upon itself the role of an individual taxation adviser and independent confirmation should be obtained before acting or refraining from acting upon the information given. The law and HM Revenue & Customs practice are subject to change. The tax treatment depends on the individual circumstances of each client. James Hay Partnership is the trading name of James Hay Insurance Company Limited (JHIC) (registered in Jersey number 77318); IPS Pensions Limited (IPS) (registered in England number 2601833); James Hay Administration Company Limited (JHAC) (registered in England number 4068398); James Hay Pension Trustees Limited (JHPT) (registered in England number 1435887); James Hay Wrap Managers Limited (JHWM) (registered in England number 4773695); James Hay Wrap Nominee Company Limited (JHWNC) (registered in England number 7259308); PAL Trustees Limited (PAL) (registered in England number 1666419); Santhouse Pensioneer Trustee Company Limited (SPTCL) (registered in England number 1670940); Sarum Trustees Limited (SarumTL) (registered in England number 1003681); Sealgrove Trustees Limited (STL) (registered in England number 1444964); The IPS Partnership Plc (IPS Plc) (registered in England number 1458445); Union Pension Trustees Limited (UPT) (registered in England number 2634371) and Union Pensions Trustees (London) Limited (UPTL) (registered in England number 1739546). JHIC has its registered office at 3rd Floor, 37 Esplanade, St Helier, Jersey, JE2 3QA. IPS, JHAC, JHPT, JHWM, JHWNC, SPTCL, SarumTL and IPS Plc have their registered office at Trinity House, Buckingway Business Park, Anderson Road, Swavesey, Cambs CB24 4UQ. PAL, STL, UPT and UPTL have their registered office at Dunn’s House, St Paul’s Road, Salisbury, SP2 7BF. JHIC is regulated by the Jersey Financial Services Commission and JHAC, JHWM, IPS and IPS Plc are authorised and regulated by the Financial Conduct Authority. The provision of Small Self Administered Schemes (SSAS) and trustee and/or administration services for SSAS are not regulated by the FCA. Therefore, IPS and IPS Plc are not regulated by the FCA in relation to these schemes or services.(01/14)

www.jameshay.co.uk JHSTT 02 OCT14 LD

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