How scrapping 55% 'death tax' could affect your DB scheme

Experts have been predicting a rise in transfers out of private DB schemes since the government revealed earlier this year that transfers to defined contribution schemes to take advantage of the Budget flexibilities would not be banned.

It’s a lot lower than expected… overall the impact on schemes won’t be as big as what has come out over the last few months

Martin Willis, Barnett Waddingham

But data on 1m DB scheme members from consultancy Mercer have shown no increase in interest for transfers ahead of April. 

Speaking at the Conservative party conference yesterday, chancellor George Osborne proposed scrapping the tax on inherited pensions. At present, inherited pensions are taxed at 55 per cent. From April next year, DC schemes that are uncrystallised or in drawdown can be passed on tax-free if the individual dies before 75.

If the individual dies at age 75 or older, the pot will be taxed at the marginal rate if taken through drawdown, or 45 per cent if taken as a lump sum.

A statement on the HM Revenue & Customs website also said: “The government intends to also make lump-sum payments subject to tax at the marginal rate (not a flat rate charge of 45 per cent). It will engage with [the] pension industry in order to put this regime in place for 2016-17.”

A reduction to the tax was expected in this year's upcoming Autumn Statement. Despite the earlier announcement, some predicted the changes would not significantly affect schemes changing approaches to retirement planning.

Martin Willis, associate at consultancy Barnett Waddingham, said: “It’s a lot lower than expected… overall the impact on schemes won’t be as big as what has come out over the last few months.”

The changes further increase the options available to DC members when deciding what to do with their pension pot.

Some argued the growing flexibility would make DB schemes look increasingly unattractive to savers, despite their security of income.

But Willis added: "Over the last few months there’s been a lot of talk about increased transfers, but that’s not really materialised yet. It’s a case of seeing what happens."

Duncan Buchanan, president of the Society of Pension Professionals and partner at law firm Hogan Lovells, said: “HMRC have underestimated the level of transfers."

He added: “Talking to clients and trustees they can see the attraction of DC. Conversion rates are favourable to the DB scheme but from a member’s point of view you can get a lot of money into your pot for giving up what would have been a small pension.”

Short-term annuities

Mark Wood, chief executive at consultancy JLT, questioned the impact the proposals might have, given the remaining, albeit reduced, taxes on pots for individuals who die after age 75.

“The big beneficiaries are [the families of] people who die under 75 and that’s a relatively small number,” he said. 

Contrary to what some predicted, Wood said the proposals may not mean the end of annuities, but rather lead to the purchase of a higher volume of smaller annuities.

“Once you get above 80 your main life expectancy is quite standard,” he said. “An annuity is quite a good insurance against living too long. This should encourage more people to buy annuities later in life.”

Wood also predicted a bounce in the popularity of annuities would be compounded by the guidance guarantee.

“Once people get guidance they will better see the advantage of annuities. The demand will go up but the amount used to buy them will decrease,” he said. 

Peter McDonald, partner at consultancy PwC, said the reforms were a "halfway stage" in need of further legislative detail. “With the lifetime allowance coming into play it’s not clear how they interact,” he said.