In the Autumn Statement, the Chancellor announced that individuals who inherited joint life or guaranteed term annuities from a member who died before the age of 75 would no longer be subject to income tax on the payments. This would apply where the death occurred on or after 3 December 2014 and the annuity payments to the beneficiary commence on or after 6 April 2015. This followed previous announcements about tax-free drawdown pensions arising in similar circumstances. The Chancellor has now confirmed that this treatment will be extended to annuities that are purchased by the beneficiary, using undrawn pension funds of the deceased member.
In addition to the change in income tax treatment, annuities from undrawn pension funds will no longer be restricted to dependants of the deceased (broadly spouse or children under 23). The member can nominate any beneficiary (eg older children). In the absence of a nomination by the member, the scheme administrator can choose a nominee. Similarly, an existing dependant or nominee holding undrawn pension funds can nominate a successor. This brings the treatment of post-death annuity payments broadly in line with the drawdown regime.
Who will be affected?
Individuals who inherit pension funds from members aged under 75 who died on or after 3 December 2014.
The income tax exemption takes effect from 6 April 2015 in respect of relevant annuity payments that commence on or after that date.
The widening of the income tax exemption is good news for individuals who inherit pension funds and would prefer an annuity to a lump sum or a drawdown pension. Based on the rules as they stood at the time of the Autumn Statement, beneficiaries would have faced a difficult choice between the security of an annuity, which would have been fully taxable, or an unsecured pension or lump sum that was tax-free. The tax disincentive of taking the more secure option has therefore been removed for most beneficiaries. The distinction still remains for some, however. Where the member died before 3 December 2014 it is not possible to avail of the tax-free annuities but it may be possible to take tax-free drawdown pensions or lump sums from 6 April 2015.
The possibility of passing on a pension to any beneficiary, rather than only dependants, will also be welcome news. Under the rules in force up to 5 April 2015, members with no dependants could only pass on their undrawn pension funds by way of lump sums, which often attract 55% tax charges. The member will now have a great deal more discretion when planning succession.
Insurance companies may also benefit from this change, as the disincentive to the beneficiary for opting for an annuity has largely been removed.