The Taxation of Pensions

Posted 29/09/2014

The Chancellor made announcements yesterday concerning Pensions and the Inheritance Tax regime. Tax and estate planning specialist Robert Chalmers looks at some of the implications for clients:

Investing in personal pension funds has in the past been something of a two edged sword. On the one hand there have been and still are significant income advantages in paying in to a pension fund with income tax relief especially for higher rate tax payers with continued income tax and capital gains tax advantages for investments held within the fund.

Such advantages have in the recent past been increasingly curtailed by the government imposing reducing limits on  how much can be paid in to a pension fund each year and how much can be held in pension funds by any one individual.

The main concern has, however, been the potential tax cost in accessing funds from the pension fund. There has for many years been the ability to withdraw the tax free 25% with income tax being payable on other withdrawals dependent on the individuals relevant rate of tax. However, one of the main disincentives to investing in pension funds has been the tax payable on retrieving the balance of the fund after the pension holder has died. When this was tied in with Inheritance Tax the effective rate could be as much as 82%. It was then reduced to 55% by the introduction of a separate pension tax. However, 55% is still a significant amount of tax to pay particularly in comparison with Inheritance Tax at 40%.

George Osborne has now announced that with effect from April 2015 the 55% tax will be removed. The rules are already complicated and the small print will need to be considered with care, but the proposals as outlined will mean that pension funds will become even more of a useful and tax efficient way of passing significant sums on to the next generation and an integral part of tax and estate planning. Generalisations are always dangerous as individual circumstances must always be applied to the rules. However, George Osborne’s announcement is not only unexpected and radical but will also introduce as complete change to how pensions are seen. The incentives and benefits are there to be had with the essential ingredient of professional advice.