2014/15 Pension Reforms Explained

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2014/15 Pension Reforms Explained

 


PENSIONS FLEXIBILITY:

DETAILED ANALYSIS OF PENSION DEATH  BENEFITS

 

Synopsis:
Proposed amendments to the Taxation of  Pensions Bill give an outline of how death benefits under money purchase  registered pension schemes will be taxed when pensions flexibility is  introduced.
 

In the summer of 2014, the Government released draft clauses for the Taxation  of Pensions Bill 2014. The legislation deals with the taxation of pension  benefits under the pension flexibility rules and will come into effect on 6  April 2015.

At the Conservative Party conference in late September, the Chancellor  announced that the ‘punitive’ tax on pension funds at death was to be  ‘abolished’ and it would be possible for individuals to pass their pension funds  to beneficiaries ‘tax free’.  The Taxation of Pensions Bill was published on 21  October 2014 but this only reduced the rate of tax payable to 45% and eliminated  the charge on crystallised funds on death before age 75. The Bill, as introduced  to Parliament, did not deal, in any detail with the taxation of, or entitlement  to death benefits.  This omission was corrected in a raft of amendments to the  Bill, at the Public Bill committee stage of the parliamentary process, announced  on 6 November 2014 via Amendments

The most important amendment concerns the payment of death benefits when any  remaining pension fund is designated into drawdown after the member’s death.  Provision is now made for individuals other than ‘dependants’ to benefit from a  drawdown pension.  In this respect, the Bill introduces the concept of ‘Nominee’  and ‘Successor’ beneficiaries. The new legislation means that any individual can  inherit unused drawdown funds or uncrystallised money purchase funds on the  death of the member.  The ability to pass on lump sums to individuals, trusts or  charities will remain, broadly unchanged although the tax treatment will alter.

From 6 April 2015, there will be two additional forms of flexi-access  drawdown pensions, bringing the total to four:

Member’s  flexi-access drawdown pension

Dependant’s  flexi-access drawdown pension

Nominee’s  flexi-access drawdown pension

Successor’s  flexi-access drawdown pension

Some existing form of drawdown will disappear.  Both member’s flexible  drawdown and dependant’s flexible drawdown will automatically become member’s  flexi-access drawdown and dependant’s flexi-access drawdown respectively from 6  April.

On the death of a member, any remaining funds can be used to provide a  pension to a dependant or nominee.  A dependant’s pension can be as a lifetime  annuity, a scheme pension or a flexi-access drawdown, but the only pension  option for a nominee is a flexi-access drawdown.  To the extent that remaining  funds are not so used, they can be paid as a lump sum, to an individual, trust,  or, in certain circumstances, to a charity.

Any funds that are designated to a flexi-access drawdown pension for a  dependant or a nominee, remaining on their death, are available to pass on in a  similar manner. However, the pension option, is only for a successor’s  flexi-access drawdown.  To the extent that remaining funds are not so used, they  can be paid as a lump sum, to an individual, trust, or, in certain  circumstances, to a charity.

Currently, a child of the member can only be treated as a dependant of the  member prior to their attaining age 23, unless they are dependant as a result of  some physical or mental impairment; see RPSM10104040.  Under the rules for  dependant’s flexi-access drawdown from 6 April 2015, it is not clear if a  dependant’s pension payable to a child will still need to cease prior to their  attaining age 23, or if it will automatically convert into a nominee’s  flexi-access drawdown or if it should be treated as a nominee’s flexi-access  drawdown from outset.  We are currently seeking clarification from HMRC on this  point and will update this section as soon as a response is received.

It is important when undertaking any planning in relation to pension death  benefits that it will be the tax regime that is in force when the member dies  that that will govern what is available and how it will be taxed.  This is the  third significant change in the tax treatment of death benefits in the last 10  years so whilst it is important to consider the changes being introduced from 6  April 2015, if death a member’s death occurs in 30 years’ time the legislation  will almost certainly be different from the rules that are being considered  now.

In respect of the following, it is important to say that it will be down to  the individuals rules of each pension scheme that will govern what benefits can  be paid in specific instances.

Treatment of existing dependant’s drawdown pensions

Where dependant’s pensions have commenced payment prior to 6 April, they will  continue to be subject to income tax in the hands of the recipient as that was  the legislative position that applied when the income commenced.  However, if  income commences on are after 6 April 2015, then the new rules will apply.  We  have seen confirmation from HMRC that in the case of a dependant’s drawdown  pension designated prior to 6 April 2015, but where no income payments have been  paid the new rules can apply from April 2015.  However, where the funds have  been designated and a withdrawal has been made, prior to 6 April 2015 the new  rules will not apply.

How can death benefits be paid from a money purchase registered  pension scheme from 6 April 2015?

On the death of the member, irrespective of whether the remaining funds are  crystallised or uncrystallised, benefits can be paid as:

A  dependant’s pension (payable as a dependant’s scheme pension, dependant’s  lifetime annuity or a dependant’s flexi-access drawdown) flexi-access drawdown  pension and/or a nominee’s flexi-access drawdown pension; and/or

A lump sum to one or more individuals or trusts, or in certain circumstances as a  charity lump sum death benefit, normally made under the discretionary disposal  rules.

On the death of the individual in receipt of a dependant’s/nominee’s flexi-access drawdown pension any remaining funds can be paid out as another dependant’s flexi-access drawdown pension, a successor’s flexi-access drawdown  pension or as a lump sum.

(i) Death  benefits providing flexi-access drawdown

On the member’s death, the pension fund can be designated to a flexi access  drawdown arrangement for one or more individuals. These individuals no longer  need to be dependants of the deceased member, but they do need to be nominated.   The nomination is normally made by the member, it is possible for the nomination  of a non-dependant to be made by the scheme administrator, but only where there  are no nominations made by the member (for a nominee or a charity) and there are  no surviving dependants of the late member.

This introduces the concept of a:

Dependant’s  flexi-access drawdown; and

Nominee’s  flexi-access drawdown pension.

Where the designation into a dependants’/nominees’ flexi-access drawdown is  made in respect of uncrystallised funds and the member died prior to attaining  age 75, they will be assessed against the late member’s remaining lifetime  allowance, under a newly introduced benefit crystallisation event, BCE 5C. (It  is not yet clear the rate of tax that will apply, but it is assumed to be 55%,  i.e. the same rate that is charged under a BCE 7.)

 The flexi-access drawdown income paid to any dependants’/nominees’ of the  member will be free of income tax, unless:

The  member died having attained age 75, or

The  designation was not made within two years, measured from the earlier of the day  on which the scheme administrator of the scheme first knew of the member’s death  and the day on which the scheme administrator could first reasonably have been  expected to have known of it; – ‘the two year window’.

(ii) Payment  of a lump sum on death of member

Any pension funds remaining, after providing for any continuing pension  income nomination(s), can be paid as a lump sum.  Here the pension scheme  trustees/scheme administrator will typically exercise their discretion in favour  of one or more from a discretionary class.

The tax treatment of such lump sums will depend upon the circumstances in  which they are paid:

Uncrystallised  rights on the member’s death prior to having attained age 75, so long as the  payment is made within two year window will be paid tax-free but will be  assessed under BCE 7.

Crystallised  rights on the member’s death prior to having attained age 75 paid within the two  year window will be tax-free. There is no BCE assessment.

Crystallised  or uncrystallised rights where the member’s death occurred prior to attaining  age 75, which are paid outside of the two year window are paid subject to the  special lump sum death benefits charge of 45%.  There is no BCE assessment.

Crystallised  or uncrystallised rights where the member died having attained age 75, are paid  subject to the special lump sum death benefits charge of 45%.

A  charity lump sum death benefit can be paid in respect of uncrystallised rights  where the member has attained age 75 or in respect of crystallised rights  irrespective of the member’s age when they died, providing there are no  surviving dependants’ of the late member.  There is no special lump sum death  benefits charge of 45% paid in respect of a charity lump sum death benefit.

The nomination of the charity is:

  • On the member’s death made by the member: or
  • On a dependant’s death made by the member, or failing  that by the dependant,  or, failing that the scheme administrator;
  • On a nominee’s and successor’s, made by the  member, or failing that by the    nominee/successor.

Lump sum death benefits in respect of uncrystallised rights on death prior to  the member attaining age 75 that are not paid with the two year window will no  longer be treated as unauthorised payments.

Nominations

It is expected that a member of a pension scheme will make a nomination (as  is currently often the case via an expression of wish) how they would like any  remaining pension funds to be distributed on their death.  Generally speaking, a  lump sum is only payable after any nominations to provide a pension income to  one or more individuals, if any, have been satisfied.

If, on the member’s death, there are no valid nominations made by the member,  either to an individual or a charity, it is possible for the scheme  administrator to make a nomination in favour of one or more individuals.   However, it is not possible for a scheme administrator to nominate an individual  to receive a nominee’s flexi-access drawdown pension benefit, if there is a  surviving dependant of the member.

For any dependants’/nominees’/successors’ flexi-access drawdown, funds  remaining on their death, it is the dependant, nominee or successor as  applicable who can make the nomination as to the individual(s) who should  receive successor’s benefits on their death.  In the absence of a valid  nomination made by the dependant, nominee or successor, being in place on their  death, it is possible for a nomination to be made by the scheme  administrator.

Who is a nominee?

An individual nominated by a member (failing whom, the scheme administrator)  to receive a flexi-access drawdown entitlement, who is not a dependant of the  deceased member is known as a nominee. The drawdown fund is known as a nominee’s  flexi-access drawdown fund.

Who is a successor?

Where an individual dies whilst in receipt of a dependant’s/nominee’s flexi-access drawdown pension, and leaves a residual fund, this can be used to provide a continued flexi-access drawdown pension to another nominated individual, defined as ‘a successor’.  Their drawdown pension is known as a successor’s flexi-access drawdown pension fund.  On the death of a successor, they can nominate another individual to receive a successor’s flexi-access  drawdown pension entitlement. The nomination can be made by the individual,  failing whom the scheme administrator.

Generational Planning

On the death of the member of a money purchase pension scheme, the funds can  be used to provide flexi-access drawdown benefits to one or more dependants, or  nominees. On the death of the dependant/nonminee the funds can be passed on as a  successor’s flexi-access drawdown fund.  This can be repeated as many times as  there are funds remaining to pass on.

The funds can eventually be extinguished, either because they are used to  provide a lump sum death benefit and thereby removed from the tax shelter  offered by a registered pension scheme, or they are exhausted by taking income  withdrawals.

In what form can pension income death benefits be paid out from both  crystallised and uncrystallised money purchase funds, when a member dies prior  to age 75 and payment of the pension income commences after 5 April  2015?

A member may make a nomination for one or more individuals to receive a  dependants’/ nominees’ pension in respect of any residual funds on their death.   A pension paid to a nominee can only be paid as a flexi-access drawdown pension.  Payments can be made to the nominated dependants in one or more of the  following forms:

Flexi-access  drawdown, structured as income withdrawal or a short-term annuity

Lifetime  annuity

Scheme  pension

If income is taken as flexi access drawdown, the income is not subject to  income tax providing that the funds are designated within the two years window.   Lifetime annuities and scheme pensions will continue to be taxable on the  recipient.

In what form can pension income death benefits be paid out from both  crystallised and uncrystallised money purchase funds, when a member dies having  attained age 75 and the payment of pension income commences after 5 April  2015?

A member may make a nomination for one or more individuals to receive a  dependants’/ nominees’ pension in respect of any residual funds on their death.   A pension paid to a nominee can only be paid as a flexi-access drawdown pension.  Payments can be made to the nominated dependants in one or more of the  following forms:

Flexi-access  drawdown, structured as income withdrawal or a short term annuity

Lifetime  annuity

Scheme  pension

In all cases income payments are taxed under PAYE assessed on the  recipient.

In what form can lump sum death benefits be paid from money purchase  funds, both crystallised and uncrystallised, when a member dies prior to age 75  and death benefits are paid after 5 April 2015?

Any pension funds remaining, after providing for any continuing pension  income nomination(s), can be paid as a lump sum in one or more of the following  ways to an individual or trust:

Uncrystallised  funds lump sum death benefit; paid within the two year window and assessed  against the deceased member’s remaining lifetime allowance under BCE 7.

Capped  drawdown funds lump sum death benefit (where the member was taking capped  drawdown)

Flexi  access drawdown fund lump sum death benefit (where the member was taking  flexi-access drawdown)

A  Charity lump sum death benefit, but only in respect of crystallised funds and if  there are no surviving dependants of the deceased member and the member has  nominated a charity/ies.

If a lump sum is paid by the trustees/scheme administrator exercising their  discretion in favour of a beneficiary, it will not be subject to tax if:

the  member died prior to attaining age 75;

it  is paid within the two year window; and

in  the case of uncrystallised rights only, they did not exceed the deceased  member’s available lifetime allowance.

If a lump sum is paid by the trustees/scheme administrator exercising their  discretion in favour of a beneficiary, it will be subject to tax if:

It  is paid within the two year window, but it is in respect of an amount in excess  of the deceased member’s available lifetime allowance.  It will suffer a  lifetime allowance excess charge at 55% under BCE 7.

It  is paid outside the two year window.  It will not be assessed against the  member’s remaining lifetime allowance, but it will be subject to subject to the  special lump sum death benefits charge of 45%.

Uncrystallised funds lump sum death benefits that are not paid within two  years of the member’s death will, from 6 April 2015, no longer be an  unauthorised payment.

In what form can lump sum death benefits be paid from both  crystallised and uncrystallised money purchase funds when a member dies having  attained age 75 and death benefits are paid out after 5 April 2015?

Any pension funds remaining, after providing for any continuing pension  income nomination(s), can be paid as a lump sum in one or more of the following  ways to an individual or trust:

Uncrystallised  funds lump sum death benefit

Capped  drawdown funds lump sum death benefit (where the member was taking capped  drawdown)

Flexi  access drawdown fund lump sum death benefit (where the member was taking  flexi-access drawdown)

A  Charity lump sum death benefit, but only if there are no surviving dependants of  the deceased member. The funds do not have to be crystallised.

As the member died having attained age 75:

there  is no test against the lifetime allowance

there  will be a special lump sum death benefits charge of 45%, unless paid as a  charity lump sum death benefit

there  is no requirement for these lump sums to be paid within two years of the  member’s death.

What can happen to any remaining funds in a dependant’s/nominee’s/successor’s flexi-access drawdown on their  death?

Any nominations, made by the dependant, nominee or successor, will be used to  decide how the remaining funds are paid as an income or as a lump sum and to  whom any such payments should be made.  If there are no such nominations then it  is possible for the scheme administrator to make a nomination.

The options in respect of these rights broadly follow those that are  available on the death of a member.  The tax liability will be dependent upon  whether the dependant, nominee or successor had died before age 75.  Where death  occurred before age 75, there is also the same requirement for benefits to be  paid within the two year window for the payments to be tax-free.  There is never  an assessment against the lifetime allowance in respect of these funds.

Tax treatment of death benefits paid after 5 April 2015 following the  member’s death

The following table may prove to be a useful summary:

Member/Beneficiary  dies prior to attaining age 75 – Benefits paid as a lump sum
Status of Funds Tax liability Benefit Crystallisation Event
Uncrystallised Tax-free if within 2 year window
  • Yes;       lump sum BCE 7
  • Yes;       income BCE 5C
Uncrystallised 45% tax if outside 2 year window No
Crystallised Tax-free if within 2 year window No
Crystallised 45% tax if outside 2 year window No

 

Member/Beneficiary  dies prior to attaining age 75 – Benefits paid as a flexi-access drawdown  income
Status of Funds Tax liability Benefit Crystallisation Event
Uncrystallised Tax-free if within 2 year window
  • Yes;       lump sum BCE 7
  • Yes;       income BCE 5C
Uncrystallised Income tax if outside 2 year window No
Crystallised Tax-free if within 2 year window No
Crystallised Income tax if outside 2 year window No

 

Member/Beneficiary dies having attained age 75 – Lump sum payments
Status of Funds Tax liability Benefit Crystallisation Event
Uncrystallised 45% tax No
Crystallised 45% tax No

 

Member/Beneficiary dies having attained age 75 –   Flexi-access drawdown income
Status of Funds Tax liability Benefit Crystallisation Event
Uncrystallised Income tax on the beneficiary No
Crystallised Income tax on the beneficiary No

 

The Taxation of Pensions Bill also covers other areas and we will give these  attention in later bulletins.

Comments

At the time of publication, 27 November 2014, there are a number of points  that are still unclear.  The main ones being:

The  disparities between the rates of tax for the BCE 7 of 55%, the as yet  unspecified rate of tax for the new BCE 5C and the 45% rate of tax for the  special lump sum death benefits charge.

The  position in respect of a dependant’s flexi-access drawdown pension paid to a  child.

 

One of the points covered by the Chancellor in his Conservative Conference  speech and subsequently in Treasury briefings to the pensions industry was that  whilst the special lump sum death benefits charge would reduce from 55% to 45%  from 6 April 2015, the government would look to change it from 6 April 2016 to  the recipient’s marginal rate of income tax.  Currently this provision is not  included in the Taxation of Pensions Bill and will need to be legislated for,  probably after a period of industry consultation (and a General Election).

For clients and readers with pension funds > £100k and especially anyone contemplating retirement in the near future it is paramount that you speak to your Financial Planner/Adviser to fully understand the impact and opportunities arising from these most welcome changes to Pension legislation.

In the current pension environment, the most important consideration for pension planning is the constant monitoring of compound growth being achieved within the funds under management.  The above changes make this even more relevant,   please see our factsheet on the power of compound growth http://www.charterbridgefinancialplanning.co.uk/directors-view/growth-and-the-compound-power-of-just-1/

 

 


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