As we move into the second half of the 2015/16 tax year it would seem an opportune time to take a look at what could easily be described as “unfinished business” with regard to the pensions freedoms introduced on 6th April 2015 by the Taxation of Pensions Act 2014. Specifically;
- What was confirmed in the July 8th Budget regarding pension death benefit charges from 2016/17?
- What is the outstanding issue relating to Flex Access Drawdown for a dependant child?
Let us consider each of these in turn.
Lump sum death benefits post age 75 2016/17
Following the passing of the Taxation of Pensions Act 2014 the death benefit charges on death post age 75 were confirmed as the marginal rate of tax for the nominated individual, if drawn as an income, but, for 2015/16, if paid as a lump sum or left to a trust, it was a flat 45% tax.
We have been waiting for confirmation as to what would happen from 2016/17 for the last two payment types. The Finance Bill 2015, following the July 8th Budget, confirms that with effect from 6th April 2016 lump sum death benefits paid on death, post age 75, to an individual will be taxed as income of that beneficiary. In addition, it has been confirmed that where a lump sum is paid to a trust, other than a bare trust, it will continue to be taxed at 45%.
However, the most interesting news is that if a lump sum has been paid to a trust and suffered the 45% tax charge, when benefits are subsequently paid out of the trust to a beneficiary, the beneficiary may get some credit for the 45% tax charge that applied when the trustees received the death benefit from the pension scheme. Finance Bill 2015 explanatory notes;
New subsection (8) allows a taxable lump sum initially paid to a trust to be treated as the income of the individual who finally receives it. That individual will be taxed at their marginal rate on the amount that the lump sum death benefit would have been before the deduction of tax. However they will be able to claim the 45% special lump sum death benefits charge paid on the lump sum death benefit as a deduction against their own income tax.
What does this mean in practice? Consider the following example;
Geoff dies age 78. The value of his pension plan is £100,000, which is paid to a trust, subject to the 45% tax charge, leaving £55,000. A year later the trust fund is still worth £55,000 and £20,000 is distributed by the trustees to one of the beneficiaries. The beneficiary is treated for tax purposes as having received £20,000 + £16,363 (the tax at 45% that would leave a net sum of £20,000) = £36,363. They will be assessed on an amount of £36,363 as income in the year of receipt. As a higher rate taxpayer the liability on this sum would be £14,545, but they will have a tax credit of £16,363 representing the 45% tax paid on the initial payment to the trust. This can be set against the beneficiaries total tax liability for the year which would provide a tax credit against other income of £1,818. So, unless the beneficiary is an additional rate taxpayer there will be a credit to use.
The key question this change raises, therefore, is, whereas considered opinion had been that using a spousal by pass trust for death benefits post 75 had become unattractive visa vis leaving direct to nominated individuals, is it worth considering again, in terms of protection and control, but with a tax arbitrage that is not what we thought going forward? As always advice will be essential and each case should be considered on its merits.
“Child dependants excluded from pension death tax reforms” – Money Marketing 8th July 2015
What was this headline all about? It appears that as the Taxation of Pensions Act 2014 was rushed through at the end of 2014 there is an unintended consequence when pension death benefits are paid to a dependant child of the deceased. Based on current legislation it would appear that;
- As a child typically ceases to be a dependant at age 23 if they were left a dependant’s flexi access drawdown on the death of a parent, they would have to stop benefitting from the pension income at age 23.
- Any “unused funds,” it is presumed, at that stage, would be paid by the scheme administrator, under their discretionary powers, either as a lump sum or as an income.
- There would be full discretion as to whom to pay a lump sum but with regard to an income that can only be paid to somebody nominated by the member. The scheme administrator can only make a nomination if there are no surviving dependants of the original member.
Until further clarity is obtained, on what appears to be an oversight in current legislation, and due to its complexity, it is advisable to consider this issue very carefully when a member is thinking of leaving death benefits to a dependant child.
Hopefully, this “unfinished business” in relation to the Taxation of Pensions Act 2014 will be resolved soon!