How much of your pension fund will the Taxman get?

You've built up a healthy pension fund and are looking forward to retirement. But if you don't survive long enough to make full use of it the Taxman can take a huge bite of what's left. What, if anything, can you do to mitigate this?

Death Benefits

Contributing to your pension has been seen by many as good Inheritance Tax (IHT) planning, The idea is that by building up oension funds and putting them in trust they could ne passes to beneficiaries IHT-free. However; the rules have recently changed, radically.

Anti-avoidance rule scrapped

Most pension funds escaped IHT using the trust arrangement, but there was a risk, particularly of late, that the Taxman might use the so-called "omission to act" rule to attack those who used their fund as a tax planning tool. This rule says where you don't exercise your rights, and this results in an increase to someone else's wealth instead of yours, the Taxman can treat your failure to act as a gift to the person who benefited. He could the apply the usual IHT charges to the value of the gift. An example is where you opted not to take your pension so that its value built up for your beneficiaries. The good news is that the omission to act rule no longer applies to pension funds.

Tax for over 75s reduced

Previously, those reaching 75 who drew money from their pension fund but hadn't used it to purchase an insurance company annunity(pension) became subject to certain tough conditions. One of these was a special tax in lieu of IHT charged on the value of the fund when the individual died. Thos tax was charged at an effective rate of 85%! There's relatively good news on this front: the tax rate has now been reduced to 55%, but there's no way to avoid this.

Tax for under 75s goes up

Those reaching 55 can choose to buy an annuity with their pension fund or, subject to restrictions, just draw cash from it. This is called a "capped drawdown". On death, where the remaining fund goes to your spouse or other dependants as a lump sum payment, there's no IHT payable on this, but it is subject to a special tax charge. Until recently the rate of this tax was 35%. The bad news is that this has recenty increased to 55%.

Tip: Whether you've reached 75 or not instead of leaving the fund as a lump sum, ask your pension provider to pay it out to your beneficicaries as a pension. This will count as their income for tax purposes, but their tax bill is likely to be at a much lower rate than the 55% which would be due on a lump sum. In fact, depending on how much other income they have, they might night pay tax on it at all.

Keep it safe

Those who reach 55 but don't need to draw the mone from their pension fund can leave it to grow in value, safe in the knowledge that it won't form part of their estate for IHT purposes or be subject to any special charges.

Tip: Because of the recent changes to the tax rates and rules applying to pension funds on death, we reccomend that you now review the death benefits for all pension schemes you belong to.

Summary

The changes to pension rules and rates mean that where you can afford to, it's now IHT-efficient to defer drawing a pension until you reach 75. Thereafter you might reduce the overall tax bill for your beneficiaries by leaving the fund to them as a regular pension rather than a lump sum.

We understand IHT can be a very confusing matter. For any more information or advice about inheritance tax please don't hesitiate to contact us on 0191 386 4786

How much of your pension fund will the Taxman get?

Summary

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