Should you still take tax-free cash?
Contained within Treasury proposals to remove compulsory annuity purchase at age 75 was a less welcome move to increase the tax on death for unused pension funds from 35% to 55%.
The consultation paper describes how pension income will continue to be taxed at income tax rates. No big surprises there.
It goes on to explain that any unused funds on death will be taxed at a rate to recover past relief, unless they are used to provide a dependant’s pension. They think that an appropriate ‘recovery charge’ would be 55%.
Under current rules, if you die before age 75 after taking tax-free cash from your pension fund but whilst still in Unsecured Pension (previously known as Income Drawdown), then the tax charge if your beneficiaries take a cash death benefit is 35% of the unused fund.
The tax charges get much more expensive after age 75, if you are in Alternatively Secured Pension (ASP), although this retirement income option will no longer be available to new retirees.
The consultation paper does point out, helpfully, that death benefits for those that die before age 75 without having taken any benefits from their pension will remain tax-free. This is the same as the current arrangement.
So, should you still take your tax-free cash?
The proposals suggest that by taking tax-free cash, you expose your beneficiaries to the risk of paying tax at 55% rather than 35% if you die before your 75th birthday and if they opt to take the death benefit as a cash lump sum. Other death benefit options exist.
Whilst death benefits are clearly an important factor when deciding on the most suitable retirement income option, they must be considered in conjunction with a whole range of other factors, including the desired level of income flexibility, annuity rates and investment risk.
If you do not need the tax-free cash from your pension fund in your bank account or direct control, then leaving it in the pension fund retains the tax-free death benefits, unless you die after your 75th birthday when they will continue to be taxed.
Of course there is nothing from stopping the Treasury from removing the tax-free status of cash from a pension fund on retirement in the future, further complicating the decisions people reaching retirement need to make about their pension benefits.
As has always been the case, it is essential to seek professional independent financial advice before making lasting decisions about retirement income options. Choosing the right retirement option is and always will be about so much more than finding the best annuity rate.