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Self-invested personal pensions – April 2015Beneficiary Fad is more than just a fad
The new pension flexibility changes coming in to effect from 6 April are the talk of the town, but the changes to the death benefit rules and tax treatment that come in from that date will also have a major impact on the pensions market. Focusing on the death benefit provisions for defined contribution pension schemes and drawdown arrangements, the pre- and post-6 April positions can be compared.
Impact of the changes
The tax charge of 55 per cent on crystallised funds for deaths before age 75 was an anomaly and a complication. It drove the need to consider leaving as much of the pension fund uncrystallised as possible, to avoid exposure to the higher death benefit tax charge. This is a welcome simplification for those taking a phased approach to drawing income.
It may have seemed like a generous move to make such payments tax–free, but the reality is that average life expectancy statistics show men currently age 55 would live to age 88 and women to age 91, with the chance of dying before age 75 being only 12 per cent and 8.5 per cent respectively.
With the prospect of a 55 per cent tax charge on leftover funds following death, the pre-2015 rules appeared to penalise those who only took a prudent and sustainable amount of income from their pension fund and encouraged early withdrawal under the new pension income rules. The new death benefit rules largely switch that around.
Death before age 75
The likelihood is that, for any members dying before age 75, the tax-free lump sum option will be the most popular. However, a scenario where a beneficiary flexi-access drawdown (Fad) would be useful is if the deceased member’s fund was invested in an illiquid asset, such as commercial property. The beneficiary could retain that asset as part of their beneficiary Fad with the option of withdrawing the property rental income tax-free.
Death after age 75
Where a member dies older than 75 a beneficiary Fad could be the most tax-efficient option for beneficiaries. The new 45 per cent tax charge on lump sums seems somewhat redundant, as designating the fund to a beneficiary Fad gives the opportunity to receive the funds at a lower marginal rate. Even when the lump sum tax changes to marginal rate tax in 2016, beneficiary Fad still has the advantage of being able to receive a series of payments over a number of years to use nil-rate, basic-rate and even higher-rate tax bands to minimise the tax charged.
The generation game
Perhaps the most fundamental change is that Fad is open to any beneficiary of the deceased member, not just financial dependants. This really opens up the scope for funds to indefinitely cascade from generation to generation with the tax position being dependent on whether the last recipient died before or after the somewhat arbitrary age of 75. Generations can be skipped so it is possible to have a scenario where grandparents leave their pension funds equally split between, for example, their six grandchildren.
Product choice
If the new death benefit rules and tax charges do increase the popularity of beneficiary Fad as anticipated, then it is important to consider how easily and cost effectively such arrangements can be established, in particular where multiple beneficiaries have been nominated.
It will be interesting to see if this stimulates more interest in the market place for family Sipps for which such scenarios are ideally suited.
Robert Graves, head of pensions technical services, Rowanmoor Group
