Changes to the taxation of Death Benefits from 6th April 2015

Since the Chancellor, George Osborne, revealed radical changes for pensions in his Budget speech on 19th March this year, we have seen further detail and clarity for the new pensions regime. The final major piece of the jigsaw has been the much awaited clarification of the taxation of lump sum death benefits, and the removal of the 55% special tax charge.

Rather than wait until the Autumn Statement, scheduled for 3rd December 2014, the Chancellor decided instead to announce some details at the Conservative Party Conference on 29th September 2014. This was quickly followed up by a note from HM Treasury, available online at: https://www.gov.uk/government/news/chancellor-abolishes-55-tax-on-pension-funds-at-death?dm_i=1W67,2UDIC,FQXW92,ABCWE,1

The headlines are:

The current position

Lump sums paid on death after age 75 are subject to a special 55% tax charge. This rate also applies to lump sums on death before age 75, where the funds have been crystalllised (e.g. in Drawdown).

For dependents income paid as annuity or drawdown, tax is payable at the beneficiary’s marginal income tax rate. A specific definition of dependant applies, meaning that this option is usually relevant to widow / widower, although dependent children can benefit.

The new position

The 55% rate of tax will be scrapped. From next April, the rate of tax on payment of death benefits from money purchase schemes will be as follows:

• Death occurs before age 75, lump sum to beneficiary is tax free
• Death occurs before age 75, income to beneficiary is tax free
• Death occurs from age 75, lump sum to beneficiary taxed at 45% (for 2015/16 tax year), then proposed to be at beneficiary’s marginal rate of income tax from 6th April 2016 onwards
• Death occurs from age 75, income to beneficiary taxed at beneficiary’s marginal rate of income tax

Whilst the headlines are indeed very positive, not all the detail is yet known. We expect the full detail to be clarified on the original expected date of 3rd December 2014.

Here are some of the areas that require further clarification:

• The statement from HM Treasury suggests that this will apply to payments from 6th April 2015, even if death occurred earlier than that. There are different views as to whether this means death at any time before that, or just those that occur from 29th September 2014. 
• We need clarification as to whether this gives a new wider definition of beneficiary, which can result in payments being made to “anyone”, not just financially dependent ones.
• It is not clear what happens if the individual did not nominate the individual, and if the Scheme Administrator is making payment of death benefits under discretionary powers.
• Can there be multiple beneficiaries, or just one?
• What is the treatment of payments to trustees of a trust e.g. a pilot / spousal bypass trust?
• What is the treatment of non-UK beneficiaries?
• How will the marginal rate of tax be calculated when added to a beneficiary’s income? Will it also result in loss of child benefit, age allowance, personal allowance etc. In certain circumstances this could result in tax rates that actually exceed the old 55% rate. 

October 1st, 2014