Pensions become estate planning top choice

The new age 75 rules confirm that the tax rate on drawn down pension benefits will be 55% regardless of whether death occurs before or after 75.

Currently the tax charge is 35% for deaths prior to age 75 and 70% for deaths after age 75, with inheritance tax potentially pushing the latter figure up to 82%.

People who can meet a minimum income requirement of £20,000 of lifetime income a year can now withdraw their excess pension pot subject to income tax.

Will people withdraw their funds?

Standard Life analysis suggests not. In addition to the income tax paid on withdrawal - likely to be at a rate of at least 40% for those who can take advantage of this flexibility - any funds withdrawn from a pension will immediately become part of the individual's estate and subject to inheritance tax. In addition, if they have used up their ISA allowance then they will have to invest any withdrawals in a net roll-up investment such as an OEIC, unit trust or investment bond.

A higher rate taxpayer retiring at 60 only needs to live to 73 for the pension death benefit, taking account of the 55% tax charge, to be better than the taking the money out under flexible drawdown and investing it in an investment bond. When inheritance tax is taken into account, a 40% taxpayer is always better off leaving their fund in the pension.

Someone who can take flexible drawdown payments and only pay 20% tax on those payments (unlikely) may be better off taking their money out of the pension fund. However, like the 40% taxpayer, if their estate will be subject to inheritance tax, they are better off leaving it in the pension.

John Lawson, Head of Pensions Policy at Standard Life said, "Whilst flexible drawdown may appear superficially attractive, leaving your savings within your pension will be the best option for the vast majority of people, thanks to gross roll-up and exemption from inheritance tax. Pensions have just become the estate-planning vehicle of choice."