Scrapping of pension death tax could open door to more final salary transfers

Chancellor George Osborne's plans to get rid of the pensions punitive 55 per cent 'death tax' levied on the remains of a pension after the death of the pension holder could lead to a significant rise in transfers out of final salary schemes.

According to new research by professional services firm Towers Watson, 9 per cent of employees approaching retirement with defined benefit (DB) pensions think they would be interested in exchanging most or all of this pension for a defined contribution (DC) pot that they can dip into as they wish.

A further 11 per cent would be interested in exchanging half of their DB pension and 24 per cent in exchanging less than half of it.

The new rules will be introduced in April 2015 and will mean that pension funds can be passed on to the next generation either completely tax free or taxed at the beneficiary's marginal rate, depending on the age of the pension holder.

mainstream choice

The changes have been hailed as a great boost for tax-efficient estate planning, but they apply only to DB (personal pension) schemes, not to final salary schemes. Instead, under the latter, a survivor's pension is payable to the spouse and dependent children if the pension holder dies first, but no further capital or income is paid out.

Will Aitken, senior consultant at Towers Watson, points out that before the Budget, hardly anyone was interested in exchanging the security and generous terms of their final salary pension for a 'forced annuity' DB arrangement.

Under the new regime, he says, 'transfers will become a mainstream choice which pension schemes need to cater for. For example, we're now seeing DB schemes considering whether to include transfer values on all pension statements so that members approaching retirement can clearly see what their choices are'.

At the moment, he adds, transfer values have to be requested, which means many people don't have much idea of how much their final salary pension would be worth if it were transferred to a defined contribution scheme.

'mass exodus'

But pensions expert Dr Ros Altmann points out that transfers may not be worth as much as might be expected. 'The guaranteed benefits are very valuable, and if the final salary scheme is underfunded, the trustees will have the right to reduce the transfer value,' she warns.

However James Baxter, managing partner of Tideway Financial Planners, anticipates a 'mass exodus' and maintains the option of a pension transfer 'will become the obvious choice for wealthier families'.

'Anyone with a family and enough wealth to not need the lifetime income guarantee of a final salary scheme will want to consider a transfer into a personal pension to take advantage of these new rules.

'At roughly 20 times the current deferred pension, final salary benefits are immensely valuable. A 55-year-old expecting a pension of £50,000 at age 60 may have a transfer value of around £1 million. This could easily be the family's biggest financial asset, if not the second biggest asset after their home.'

a 'great shame'

Although he recognises that some people will prefer to stick with the security of a lifetime income, Baxter believes it would be 'a great shame' for those final salary scheme members who are comfortable with the increased risks involved not to pass on their pension pot, 'especially where this can be achieved at little cost to the member in terms of pension income'.

Aitken anticipates that in practice most people will want to split their pension between the two schemes, though he points out that 'schemes usually offer an "all or nothing" choice' as far as transfers are concerned.

'Transfers can only grow in popularity from their current - virtually non-existent - levels, especially now that less tax will be due when unused DC pensions are passed down the generations,' he says. 'However, it would be foolish to predict a stampede to the exits. It is human nature to stick with what we have, and a secure lifetime income is not something to give up lightly.'

Altmann agrees that it's unlikely there will be a mass exodus from final salary schemes. 'The survey evidence so far suggests most people will keep their final salary scheme benefits rather than trying to cash out,' she says.

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