One of the biggest causes of negative perceptions towards pensions has been the idea that your family get nothing when you die. “Drop dead the day after you retire and the insurance company keeps the lot,” has been the accusation that pensions have, for years, struggled to shake off.
But Chancellor George Osborne’s pensions revolution means that from next April this will no longer be the case. As well as giving easy access to pension assets, and taking away the need to buy an annuity, the new pensions regime also makes it much easier for retirees to pass pension assets on to heirs after they die.
Most people will find they need all the money they have saved to see them through a retirement that is likely to be longer than they had expected – on average retiring Britons underestimate their life expectancy by around seven years. But even though the majority of people may never use them, the new rules on inheriting pension assets will make saving more attractive to auto enrolment scheme members.
Under the current rules most people in defined contribution schemes have bought an annuity at retirement that has paid an income for life to them and their partner if they have one. Only wealthy people with large pensions have been able to take advantage of an option called ‘income drawdown’ that allows retirees to remain invested in the stock market and draw a fixed income from their fund each year.
Under today’s rules, if the income drawdown investor dies aged 75 or older the fund passes to their estate subject to a 55 per cent tax charge, unless it is to a spouse or child under age 23, when in this case the pot passes tax free. Should they die before age 75, the fund can pass to any beneficiaries if no withdrawals have been made from it, but if some cash has been drawn, it is taxed at 55 per cent at death.
From April 2015
From April 2015 it will be possible for people to access their defined contribution schemes as they wish from the point of retirement and it will no longer be a requirement to purchase an annuity.
In addition, the 55 per cent tax on death is being scrapped. In future, all funds will pass free of tax on death before age 75, regardless of whether withdrawals have been made. And what’s left of the funds of those who die when they are past their 75th birthday can pass free of tax to beneficiaries, who can then withdraw it and only pay tax at their marginal income tax rate.
While work needs to be done to make income drawdown more accessible and cost effective for those with smaller pots, what all this means is that rather than being the closed vaults they were perceived to be in the past, pensions are now a super-efficient vehicle for long-term saving, whether for retirement income or for other purposes for that matter.
In fact for anyone over 55, and even those approaching that age, the new flexible access rules mean putting money into a pension and keeping it there until it is needed is now a considerably more tax-efficient way of saving than putting it in an ISA. Not only will money paid in pass on to heirs in a tax-advantaged way in the event the pension saver dies, but the contribution will also attract tax relief of at least 20 per cent, growth is largely tax-free and a quarter of it can be withdrawn tax-free.
The reality is that most people will probably need all the money they have saved to see them through their retirement. For many, knowing they can, if they choose, leave some of their fund to their loved ones as a bequest will prove attractive. It’s also another reason for employers to want to shout about the great pension they are offering their workers.