By Fiona Tail, Technical Director, Intelligent Pensions
Why 75?
There is some logic behind the choice of the 75th birthday for the ‘cliff edge’ changes to taxation. Originally considered to be an age that relatively few people would reach, it was by the early 90s the average life expectancy for newborn babies (across both sexes) in the UK. By 2004, when pension simplification was being drafted, it was the average life expectancy for a newborn male.
Death prior to age 75 is considered to be ‘early’ and the tax treatment is deliberately more favourable than for those who reach a more ‘normal’ age. HMRC’s view is that pensions are intended to be for retirement and not legacy plans.
Key planning issues
Since clients cannot (legally) arrange to die on time, the best option is to review their retirement plan and identify any actions which should be taken ahead of the fateful day.
1. Contributions
Tax relief is not available on pension contributions made after age 75 and as a result many providers do not accept them. Clients who still have earned income, and no issues with the Annual (AA) or Lifetime Allowance (LTA), may wish to make a last payment into their plan while they still can. This will reduce their income tax bill and also the value of their estate.
2. PCLS
Contrary to some people’s belief, it is possible to take PCLS from a pension after the age of 75 (providing there is still some LTA available), and we normally advise them to do so if possible. This is for the simple reason that this part of the fund would be paid tax-free to the member but would now be taxed if it was paid as a death benefit.
An exception to this would be where the extra cash would push the client’s estate over the Nil Rate Band. Depending on the tax status of the beneficiaries the resultant IHT tax charge could be greater than the tax charge on the death benefits.
3. LTA issues
Another key factor in the tax equation is the LTA. Any remaining pension assets will be tested against the LTA at age 75 even if they have been previously tested as part of an earlier Benefit Crystallisation Event (BCE). Again, other than by dying or cashing in the fund, this test and its timing is inevitable.
There are 2 main ways of dealing with this:
1. Make income withdrawals ahead of age 75 in order to reduce the fund value which is tested.
2. Leave the money invested and ‘suck up’ the charge when it comes.
At first sight the latter option does not look very appealing, however it must be remembered that the LTA tax charge does not come with an invoice. The tax is deducted from the fund and there is no actual demand for cash from the revenue. If the client starts to withdraw income, that income (other than any PCLS) will be taxed, potentially at 45%, and it will also form part of the client’s estate and could be taxed again on death.
If the funds are left in the pension, they will be subject to a 25% LTA tax charge. This does not however affect the client’s income tax status and or add to their estate. Granted, the benefits will now be subject to a tax charge on death, but the rate of tax is determined by the tax status of the beneficiary not the member. Clients may therefore wish to consider changing their nominated beneficiaries to younger family members who might be non-taxpayers or pay basic or the intermediate rate of tax.
4. Annuity purchase
It used to be compulsory to purchase an annuity at age 75 and although this is no longer the case, it could be a good time to do so.
Firstly, the huge advantage of tax-free return of fund on death has now been lost, and secondly this is the age when mortality drag starts to have a significant impact on annuity rates.
Older clients are also much more likely to have predictable income requirements, and to potentially benefit from enhanced rates.
5. Policy conditions
Lastly, a word of warning. Some pension plans contain provisions which limit benefit or investment options after the age of 75. While it is true that older clients are likely to be more risk-averse this does not mean that switching their fund into cash is a good outcome.
Clients may still wish to make their own choices and may need to switch into another plan to do so.
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