Pension Changes 2015: The new rules for passing your savings on

By Brian Milligan
Personal Finance Reporter, BBC News

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Image caption,
400,000 people with pensions in drawdown could benefit from next year's changes

The Chancellor George Osborne has announced further changes to the future of pensions, which will take effect from April 2015.

Behind them is a shift of emphasis in what a pension is actually for.

Once a pension existed purely to provide an income in later life.

But now - under Mr Osborne's vision - a pension fund could become a new tax-efficient savings vehicle, something that will be particularly attractive to those with large savings.

More than that, it will be possible to pass the pension pot on from generation to generation, just like the family silver.

Who will benefit?

Anyone who has a defined contribution pension - where their contributions build up in a pot, which is then used to buy a retirement income. This includes most auto-enrolment schemes. In the UK roughly 12 million people currently save into such pensions - and, according to the Association of British Insurers (ABI), 400,000 people already use them to provide an income - so-called "pension drawdown".

The changes will not affect those on final salary company schemes - or the state pension.

How will the changes affect those who die before the age of 75?

Currently, anyone who inherits a pension fund which is already being used to provide an income, has to pay 55% in tax. The only exceptions are spouses or children under 23. Instead, they are required to pay income tax on any income they draw from the fund - at either 20% or 40%. If a pension fund has not been used to provide an income, there is no tax payable.

From April 2015, anyone who inherits a pension fund will have no tax to pay - whether it is already being used or not. They will not be liable for income tax either. But there will still be a limit of £1.25m (£1m from 2016) on the amount of money anyone can have in their pension, unless they want to pay 55% tax on income from it.

How will the changes affect those who die after the age of 75?

Currently anyone who inherits an unused pension pot from someone older than 75 has to pay tax at 55%. Spouses however can inherit the pension (but no other beneficiaries), and pay income tax on the income they receive.

But from April 2015, all beneficiaries will only have to pay income tax. Depending on the rate of tax they pay - their marginal rate - they will have to pass 20% or 40% to the taxman.

How many people have been paying 55% tax?

Until April 2011, anyone over the age of 75 had to buy an annuity. In the three and a half years since then, relatively few people will have paid tax at 55%. But neither the Treasury nor HM Revenue and Customs will say exactly how many.

What will happen to annuities?

Annuities - where a pension pot is used to buy an income for life - will continue to be the only way of guaranteeing a particular level of income. But once an annuity is purchased, it cannot generally be passed on to someone else, other than a spouse, without considerable expense.

As a result, the new tax rules are likely to make annuities look even less attractive, in comparison to keeping savings in a pension fund.

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Image caption,
Annuities will look even less attractive to savers

Can I use a pension to avoid inheritance tax?

Up to the age of 75, passing on a pension will carry no tax liability - whereas other assets, like money in shares or savings accounts - will be liable for Inheritance Tax (IHT). Currently passing on anything worth more than £325,000 to your beneficiaries is taxed at 40%.

Even beyond the age of 75, most inheritors would only pay 20% income tax on the money they receive from a pension fund - far less than under IHT.

So it might make sense for pensioners to put as much as they can into a pension fund, although there is a lifetime limit of £1.25m.

What will the impact be on final salary schemes?

The new freedom to pass on pension pots will make final salary schemes look less attractive. When a worker in a final salary scheme dies, the pension dies too, and can usually only be inherited - in part- by a spouse.

But some schemes allow members to transfer out. So in exchange for an annual pension of £10,000, a worker can accept an equivalent capital sum - say £300,000. From April 2015, that sum can be passed on to beneficiaries.