Personal PensionOct 10 2014

Death tax cut further benefits capped drawdown ‘loophole’

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In August, FTAdviser reported that providers predicted more advisers may seek to move their clients into capped drawdown in advance of new pension freedoms coming into force next April, due to a carve-out in rules designed to close a tax loophole.

The reduction in the annual allowance to £10,000 will not apply to capped drawdown, so rules governing which will be ‘grandfathered’ into the new regime. This means that savers in capped drawdown before April 2015 will retain their £40,000 annual allowance.

Mr Osborne announced on 29 September that there would be no inheritance or income tax if pension funds are passed. Pension funds paid out before or after the age of 75 will no longer be subject to the 55 per cent tax charge when transferred as a lump sum within a pension.

Some providers have now predicted people moving into capped drawdown as a result of the most recent announcements on death tax.

Claire Trott, head of technical support at Talbot and Muir, said that there had been much discussion with advisers over the possibility of going into capped drawdown this tax year, to ensure that clients were not penalised regarding their annual allowance in the future.

Ms Trott said: “One of the big concerns about doing this was the impact on the death benefits, this however is now not likely to be an issue. Before the chancellor’s announcement, clients would have risked the loss of 45 per cent of their fund on death if not left as an income to a dependent, but left as a lump sum.

“The new rules mean that provided they die before age 75, then there is no change in the death benefits between crystallised and uncrystallised funds, meaning one of the hurdles to taking tax free cash now and entering capped drawdown to protect the ability to make additional contributions in the future, is gone.”

Ms Trott added that advisers were wary of recommending that clients enter capped drawdown without the real need for the tax free cash and income immediately, because of the detriment to the death benefits, despite the fact it would give them greater flexibility in the future.

She said: “Advisers will be more able to make this recommendation without the concern that their client might unexpectedly die and suffer a loss of 55 per cent of their fund value in tax charges that may otherwise have been avoided if the fund was left intact.

“I feel advisers who had previously dismissed this as an option will reconsider and engage with their clients over 55 who are likely to be in the position to make good use of a lump sum without restricting their future options. The money purchase annual allowance rules create a £30,000 reduction in the annual allowance so this could be very important for some.

Ms Trott also said it is important that advisers have these conversations now so it is not all left until February or March, and that “lots of people are having a good, hard think about it”.

Martin Tilley, director of technical services at Dentons, agreed that one of the barriers had been removed by the chancellor. “There’s no longer a barrier in place to those individuals who want to take tax free cash, and being in capped drawdown is better because of the £40,000 limit.

“[However] by going into capped drawdown you are lumbering yourself with an upper limit and the triennial reviews which set the maximum income you can draw.

“Another reason why people might want to do it [move into capped drawdown] is to keep their options open. I think it’s certainly an additional point to consider [death tax benefits] because you can keep options open to continue to drawdown.”

Robert Graves, head of pensions technical services at Rowanmoor, said that there was an indirect advantage in going into capped drawdown because of the better benefits from the new death tax regime, but that the main driver he could see for going into capped drawdown was the difference in the annual allowance.

Mr Graves said: “If one of your overall objectives is to use your pension plan to pass on your pension to the next generation then the £40,000 limit might be advantageous.

“The fact that they’ve removed the difference between crystallised and uncrystallised does give people a hell of a lot more flexibility.”

However, Matthew Brown, retirement services director at Broadstone, said he did not expect there to be a rush of people going into capped drawdown as a result of the changes to the death tax regime.

He said: “I don’t know if I’d necessarily expect to see a rush of people [going into capped drawdown], but there is definitely one less barrier.

“From an advisers perspective you have to go lengths to make sure people understand and a barrier is removed. Removing a level of complexity is welcome. I’ve never know anyone to be put off by the death benefits and it never formed a deterrent in my view but it was an extra level of complexity.”

ruth.gillbe@ft.com