George Bull: Scrapping of 55% tax rate on pensions goes further than expected

Following Chancellor George Osborne’s announcement that he will scrap the 55% tax rate on inherited pension funds, HM Treasury has now confirmed that this will be effective from April 2015. 

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Before this announcement, members of defined contribution (DC) pension plans faced a difficult choice. If they opted for an annuity but died early, then the annuity provider would profit, but if they did not take one and instead left their funds in the pension pot, then the taxman would take up to 55% of their savings on death.

In the discussions taking place since the 2014 Budget, there were suggestions that the 55% tax rate would be reduced to 40% and that this would be the same rate as the current inheritance tax rate.

By abolishing the 55% tax charge in certain circumstances, Osborne has gone further than expected. Prior to April 2015, the 55% tax charge still applies to untouched DC pension pots left by members aged 75 or over, and pots from which money has already been withdrawn.

Inheritors where the deceased was over 75 will, in future, only pay the marginal income tax rate if they are prepared to take the money out gradually as additional income. There will be a 45% tax charge if they want to take it all.

The position is simpler if the deceased was under 75 and the pension is left untouched. No tax will be paid by the inheritor regardless of whether the money is taken in a lump sum or instalments.

This is great news for the estimated 320,000 pension pot holders who will be affected by the change, because it removes an important part of the ‘heads I win, tails you lose’ decision which people had to make about post-retirement income. But it might not quite be the tax-free bonanza as first thought, particularly where somebody lives beyond 75.

The Chancellor may well have calculated that the estimated £150 million cost of this will not significantly reduce the estimated £3 billion-plus tax increases between 6 April 2015 and 5 April 2019, which are part of the other pensions changes.

This won’t be the last we hear about this.

For employees with other means, DC schemes will now offer the prospect of tax relief on contributions to the scheme, tax-free growth within the scheme and tax-free transfer to the next generation in certain circumstances.

For those who can afford it, that will have the effect of making DC pension plans a uniquely tax-favoured means of passing wealth down from one generation to the next.

George Bull is senior tax partner at Baker Tilly.