Contractors won't mourn the demise of the pensions death tax

Last week’s Labour conference made all the right sounds to IT contractors, but as far as the bottom line for such workers and their families is concerned, it’s the Tory conference and its announcement on pensions that really matters, writes ContractorMoney’s Tony Harris.

That’s because in his speech to the Conservative party in Birmingham, George Osborne yesterday said that the 55% inheritance tax levied on defined contribution pension pots would be killed off entirely.

No more pensions “death tax”

This is a monumental move because, currently, hardworking contractors who pay into a pension are held to ransom by this most hated tax which prevents their children (and grandchildren) from inheriting the majority of their nest egg when they die.

In fact, before the chancellor got to his feet yesterday, if you were under the age of 75 and were in receipt of benefits from your pension, then your descendants would be forced to pay tax at their highest marginal rate if they were to draw an income from your pension. If you are aged over 75 before yesterday, then that tax rate would increase dramatically to 55% of your pension fund, which would adversely impact significantly on your loved ones’ inheritance.

This pensions “death tax” has long been a bone of contention among the contractor community and we encounter questions on a daily basis from clients concerned about their savings ending up in the taxman’s pocket, rather than in the hands of their loved ones. But the chancellor seems to have recognised that this charge on the pensions of dead people could have been the final nail in the coffin for the Conservatives, and it would have been hammered in hardest by ‘grey’ voters, who are becoming ever more influential in an ageing Britain.

Indeed, Osborne is rumoured to be hoping that his announcing that a deceased person’s pension can be passed tax-free to their loved ones could swing many of the older population towards voting Conservative. But because of how it can sting freelance professionals and their families, the elderly won’t be alone in welcoming the sight of a Tory axe to the pensions death tax.  

What it means for pensioners, hard-workers, inheritors

According to the proposal, tomorrow’s inheritors will only have to pay their marginal income tax rate on pension benefits received after the death of someone aged 75 or over. They will pay no tax at all if the deceased was under 75 even if the pension had been in drawdown, as Osborne proudly declared. “I could choose to cut this tax rate,” he said. “Instead I choose to abolish it altogether. People who have worked and saved all their lives will be able to pass on their hard-earned pensions to their families tax-free".

While the chancellor’s boastful demeanour might irritate some, there is consistency from a policy standpoint. Again though, the chancellor was in chest-beating mode: “The party that gave people the right to buy their homes now gives them the ownership of their own pension too” with this raft of “far reaching new freedoms” for how people access their pensions. He was referring not just to his latest pensions-related ‘rabbit out of the hat’ but to the previous one as well -- the massive overhaul to pensions introduced in the March 2014 Budget.

Yesterday’s announcement was leaked to the press and it has been widely publicised that the changes would come in to effect next April. But in a surprise twist, the chancellor announced that the changes would be “effective from today”.

From our research it would appear that officially, the new rule changes come into force from April 2015, however beneficiaries in this interim period could delay their payment to take advantage. The conference hall heard: “Freedom for people’s pensions, a pension tax abolished, passing on your pension tax-free. Not a promise for the next Government but put in to practice by Conservatives in Government now”.

The Autumn Statement on December 3rd is expected to define how the policy is to be funded. Initial estimates are that it will affect 320,000 people at a cost of £150million a year, resulting in a potential windfall of £500 per person.

What it means for contractors

This latest change to the pensions landscape will have a direct impact on almost every contractor who invests in a pension, as it affects all defined contribution pensions. In fact, the only people who will not benefit will be those with a final salary scheme which some contractors may still have from a past life in the public sector or working for a large employer.

Whether you have been contributing to a pension personally or via your limited company, all contributions made since you have been contracting will be exempt from the previous 55% death tax. This will have a really positive impact on your children and grandchildren and makes pension investment even more appealing, not only for the tax benefits you receive today on your contributions, but also on the tax benefits now available to your descendants when they inherit.

What Osborne is effectively saying is that for the first time, you, the contractor, can build up a pension fund, safe in the knowledge that there is the ability to drawdown on savings without restriction from the age of 55. But also for the first time, he's saying that any unused savings will be passed down to your family tax-free when the time comes. So this really is a monumental shift in pension taxation and will equate to a significant saving for each and every contractor in the UK.

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Written by Simon Moore

Simon writes impartial news and engaging features for the contractor industry, covering, IR35, the loan charge and general tax and legislation.
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