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Death benefits

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22/09/2011 Written by: Adrian Walker

Income withdrawal and death benefits

Adrian Walker looks at the death benefit implications of the new income withdrawal regime.

The beginning of this tax year saw significant changes to the tax charges on death benefits from registered pension schemes. These changes, aligned to the increased retirement flexibility also now available, bring new advice issues and financial planning opportunities with clients potentially affected.

Clients can now defer taking any retirement benefits until after their 75th birthday, still have a pension commencement lump sum available to them, and continue to take income withdrawals, through both capped and flexible drawdown, beyond that age (subject to their pension arrangement having this flexibility).

However, there are issues that this flexibility raises. We are not immortal – one thing is certain – we will die. The table below summarises the current tax treatment of the lump sum death benefits from pension rights built up in registered pension schemes.

  Uncrystallised Crystallised
Pre-age 75 No tax charge on lump sum death benefit below available Lifetime Allowance – 55% tax charge on lump sums above Lifetime Allowance – payable by beneficiaries. 55% tax charge on drawdown lump sum death benefits – unless payable to registered charity.
Post-age 75 55% tax charge on any lump sum death benefit – unless payable to registered charity. 55% tax charge on drawdown lump sum death benefit – unless payable to registered charity.

 

The most significant of these changes, the increase in the tax charge from 35% to 55% of funds held in income withdrawal for clients dying before age 75, bring into focus alternative planning ideas to reduce the potential tax liability on the capital value. Some thoughts to consider for clients in this area of the market are:

  • Income withdrawal funds (whether capped or flexible drawdown) – should clients take income from the fund and reinvest for themselves, maybe through recycling of income back into new pension contributions? If intending to leave value for others to benefit from should they gift income to them while alive, reducing the effective rate of tax the benefit will suffer?
  • Starting to take pension scheme benefits – use the phased approach to retirement income provision to limit the capital fund values that will move into income withdrawal or annuity purchase in the early years of provision.
  • Intending to leave income withdrawal funds to a surviving spouse or financial dependant – ensure the scheme will provide an income withdrawal facility for them. It could be more tax efficient for the spouse to take income from capital rather than receive a lump sum that suffers the 55% tax charge.

These changes do give the opportunity to review how previous planning may need to change for clients in these market segments and highlights once again how important the need for independent financial advice is on such complex planning issues.

This article is based on Skandia’s interpretation of the law and HM Revenue & Customs practice as at September 2011. We believe this interpretation is correct, but cannot guarantee it. Tax relief and the tax treatment of investment funds may change.

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