For anyone studying for their R04, J05 or AF7 exams, recent regulatory consultation papers regarding pensions tax have changed the goalposts. The Brand Financial Training team explains.
Since the pension freedoms in 2015, it’s fair to say that the tax efficiency of pension death benefits have been a key consideration in retirement income planning.
Those candidates who have been active in this area will know that as a general rule, best advice would be to take income from the most tax efficient sources. It has become a generally accepted maxim that retirement income ought usually to be funded using ISAs or general investment accounts first and pensions last.
This may seem counter-intuitive on the face of it, given that the intended purpose of a pension is to be used as a retirement savings vehicle. However, it is also common-sense financial planning given the generous tax benefits a defined contribution pension pot enjoys on death.
Since the freedoms, the beneficiaries of any scheme member who passes away prior to the age of 75 have been able to receive the death benefits from those arrangements free of any tax at all. This is subject to a lifetime allowance test for uncrystallised benefits, which in reality would only impact a small and very wealthy minority. Beneficiaries being any dependent or nominee selected by the individual. When combined with being outside the estate for inheritance tax purposes, it is small wonder that pensions are now being viewed as primarily an intergenerational planning vehicle.
Those who are active in the defined benefit transfer space will know that this generally compares favourably with the benefits available from a defined benefit scheme. Such schemes are only able to pay income-based death benefits to a party meeting HMRC’s classification of a dependent and, whilst not being subject to a lifetime allowance test, these payments are taxable as the income of the beneficiary regardless of the age of the member on death. The facility to pay wider and more tax efficient death benefits is commonly cited as a motivation for a client’s desire to transfer out of a defined benefit pension scheme.
Most candidates who are associated with providing pension planning will know that the lifetime allowance is to be formally abolished with effect from 6 April 2024. The legislation confirming this was confirmed as having received Royal Assent on 11 July 2023. This means that all of the necessary stages of the legislative process have now been completed.
However, there is also potentially a nasty sting in the tail with regards to pension death benefits. On 20 July 2023, the government published Pension Schemes Newsletter 152. This newsletter confirmed that the government had published, and was consulting on, draft legislation for the Finance Bill 2024. The draft legislation and consultation was published on 18 July 2023, which the government has taken to referring to as L-day (legislation day) – an ironic echo of the pensions simplification A-day from 17 years ago.
Pension Schemes Newsletter 152 states the following:
‘BCE5C and BCE5D, international and transitional elements are not included in the legislation published at L-Day, however respondents to the consultation are welcome to provide thoughts on these areas’.
To recap, benefit crystallisation events (BCEs) 5C and 5D are the ones which test uncrystallised funds placed into beneficiary’s flexi-access drawdown, or used to buy a beneficiary’s annuity, against the lifetime allowance. The result historically being that, as per the above, payments from such arrangements will be free of tax on death pre-75, provided the sums do not exceed the lifetime allowance.
The government’s current thoughts in relation to the above BCEs are contained in its updated policy paper ‘Abolition of the lifetime allowance’ (which is included in the consultation under the heading of ‘Draft income tax legislation’). This includes the following sneaky little caveat:
‘Individuals will still be able to receive the benefits which are currently tested against the LTA at BCEs 5C and 5D, but the values will no longer be excluded from marginal rate income tax under ITEPA, with effect from 6 April 2024’.
The implication of the above statement seems to be that, with effect from next tax year, the treatment of income-based death benefits from uncrystallised money purchase funds pre-75 will effectively be treated the same way as post-75 ones and defined benefit dependents pensions.
The government has invited comments on its consultation, which are due before 12 September 2023. However, it appears that another simplification exercise may be in the pipeline (mind you, is there really any such thing when it comes to pensions?), this time relating to the tax treatment of death benefits.
This is definitely one to keep your eye on and may have definite implications for those studying for their R04, J05 or AF7 exams. The relevant papers can be found here:
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