UK Pension Changes – What you should know
Upcoming changes to the UK pension system will take effect from April 2015. These changes, recently outlined by the Chancellor, equal good news for UK and US citizens alike. Not only will pension holders have more flexibility in the way pensions can be drawn down and be passed on to beneficiaries, but the 55% Lump Sum Death Benefit tax on pension funds will be abolished allowing individuals to pass on more money at their death.
Flexible access to pensions from age 55
Anyone with a defined contribution pension and age 55 or over in April 2015 will have the ability to drawdown their pensions however they wish. The change increases potential tax planning opportunities as you have the ability to choose a lump sum withdrawal or a periodic staged drawdown over time. The first 25% withdrawn may be free of tax with the rest subject to income tax at your highest marginal rate.
Removal of restrictions associated with pension drawdown
From April 2015, all restrictions and limitations placed on the amount of drawdown investors are able to take each year will be eliminated. With this option, the investor maintains control over the investment of the pension fund. And, it allows you increased flexibility on when and how much to drawdown and how you want to pass funds onto heirs. However, this option also bears some risk as it is no longer a secure annuity and requires careful management to ensure an investor doesn’t unknowingly deplete the account through excessive income drawdown. If you are already in income drawdown prior to April 2015 you will have the option to move to the new unlimited regime if preferred.
Transferring a defined benefit pension to a defined contribution pension
Anyone with a defined benefit pension will also be able to take advantage of the increased flexibility offered in the new legislation and make unlimited withdrawals. But, in order to do so, you will be required to transfer the assets to a defined contribution pension. In doing so, you could lose some very valuable benefits, so it will be important to take advice from your adviser before making this decision.
55% Lump Sum Death Benefit Tax Abolished
All individuals (regardless of age) will now have the ability to nominate a beneficiary to inherit the pension at their death, rather than pay the 55% charge. This beneficiary can be anyone of your choosing and is not required to be a dependent.
There is slightly different treatment on inherited benefits depending on whether the pension holder died before or after reaching age 75. This treatment is outlined below:
- Before age 75
If the individual dies before age 75, they will be able to pass on the remaining defined contribution pension to anyone as a tax free lump sum, regardless of whether it is in drawdown or uncrystallised. The beneficiary will pay no tax on the money they subsequently withdraw from the pensions, whether it is taken as a single lump sum, or accessed through drawdown. It is important to note that the changes are only applicable to defined contribution schemes that have not be used to purchase an annuity or are being paid through a scheme pension.
- At or after age 75
Any individual who dies with uncrystallised pension funds or while in drawdown at or after reaching age 75 will also be able to nominate a beneficiary to inherit their pension assets. The beneficiary will be able to access withdrawals from the pension flexibility over time and there are no restrictions on the amount that can be withdrawn at once. As funds are withdrawn, the beneficiary will pay tax at their marginal rate of income tax. If they choose to receive the pension as a lump sum payment, a one-time tax charge of 45% will apply. HM Treasury notes that the Government intends to also make lump-sum payments subject to the marginal rate of tax (not a flat rate charge of 45%) and it will aim to put this into effect for 2016-17.
Implications for US Persons
The upcoming changes are a welcomed development for many people including Americans. As the UK Lump Sum Death Benefit Tax on pensions is not considered to be an Inheritance Tax it cannot be used as an offset against US estate tax. Any US persons who would be subject to a US estate tax liability will now not be liable for a double tax on their assets.
Previously, with proper tax planning, certain Qualifying Recognised Overseas Pension Schemes (QROPS) were sometimes viewed as more favourable when it came to estate tax planning benefits. If the QROP member was a non-UK resident for 5 complete tax years, there was no Lump Sum Death Benefit tax due (depending on the QROP jurisdiction). Therefore, for individuals who planned to retire in the United States holding a QROP may have meant their pension pot would not have been subject to the 55% Lump Sum Death Benefit tax and allow for beneficiaries to receive a greater inheritance. However, with the pension changes, there is less perceived benefit from QROPs and there is more incentive to keep UK pension assets onshore.
In fact, the best place to allocate your pension dollars and the amount you should ultimately seek to contribute to a pension, as well as your planned drawdown strategy in the future should become a planning point of discussion with your financial adviser in the near future.
Note: The changes are a combination of draft guidance and the Chancellor’s recent conference statement both of which are not yet law and may be subject to change/amendment.