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Flexible income route can reduce inheritance tax bill for pensioners

1st February 2012 Print

People who are eligible for flexible income drawdown on their pension savings can use the scheme to significantly reduce their inheritance tax liabilities, according to investment specialist Skandia.

When it comes to taking income from a pension, there are a number of choices available. To qualify for flexible income, someone needs to have a secure pension provision of £20,000 a year. They can then use flexible income to provide unlimited access to the rest of their money purchase pension savings. This flexibility is extremely useful and when comparing it against the way in which traditional capped income drawdown operates, the difference on someone's tax position is quite surprising.

The key reason why flexible income could be more tax efficient than capped income is that under capped income, the maximum amount of income a person can take each year is limited by legislation. The limit is calculated as a percentage of money in drawdown, and, due to the 15 year gilt yield reaching record lows, more money needs to be moved into drawdown to provide the desired net income. Money held in drawdown waiting to be taken as an income is subject to a 55% tax charge on death.

If a person does not yet meet the £20,000 income criteria for flexible income, but they are expecting to start receiving a State Pension or other secure pension income in the foreseeable future, it may be worth using other savings such as ISAs to provide their immediate income needs.  This will leave their pension savings untouched until they become eligible for flexible drawdown when they can use their pension savings more effectively in delivering their longer term retirement income plans.

Currently any protected rights cannot be included in the provision of flexible drawdown. However, from 6 April 2012 protected rights will be abolished, which will result in more people being able to use flexible drawdown.

Adrian Walker, Skandia's pension expert, comments: "Flexible drawdown was only introduced in April 2011, and is still fairly new, with a limited number of providers offering it. Wealthy individuals could consider using flexible drawdown as a way to deliver retirement income more efficiently from their unused pension savings, avoiding a potential 55% tax liability if they die before age 75.

"It is surprising the difference using flexible income over capped income can have from an estate planning perspective. In the example, a person's estate could be over £20,000 better off initially if they received their retirement income using flexible drawdown. Magnify this by the significant sums some people hold in their pension savings and you can start to see the dramatic difference such planning can have."