December 10, 2010 5:36 pm

Tax boost for wealthy heirs

Tens of thousands of investors are expected to use their pension pot to avoid inheritance tax each year after the government announced a shake-up of the regime this week.

From next April, people will no longer have to buy an annuity when they reach 75 and will be able to keep their pension invested in the stock market for as long as they want.

The move will give investors greater control over their pension pots and enable money to be passed down to heirs more easily.

A flat tax charge of 55 per cent on death will apply on pensions that are not used to buy an annuity and are instead invested in the stock market – known as income drawdown – with no inheritance tax payable on the funds. This is far lower than the previous charge of 82 per cent after the age of 75 for those who moved
into an alternatively secured pension.

Pension advisers said the lower tax rate would encourage wealthy investors to leave their pension money untouched and pass it down to heirs, saving them significant tax bills. Pension money withdrawn is taxed at an investor’s personal rate of income tax, likely to be at least 40 per cent for the wealthy, with inheritance tax of 35 per cent also payable.

“Fifty-five per cent might seem high, but if you do the numbers, it’s almost always better off to leave your money in the pension,” said John Lawson, head of pensions policy at Standard Life.

“Pensions have just become the estate-planning vehicle of choice.”

Passing the pension to heirs would not make sense for basic-rate taxpayers or those whose estate will not be hit with inheritance tax.

About half a million people a year either buy an annuity or activate their pension by moving into income drawdown. Income drawdown is only recommended for wealthy investors who can afford to take stock market risk with their pension.

Under the new rules announced this week, investors will only be allowed to move into “flexible” drawdown if they can prove they have a separate income of at least £20,000 a year – for example through the state pension or a final salary scheme – in order to reduce the risk that they could run their pots dry and end up relying on the state.

The government confirmed that alternatively secured pensions would be scrapped. The pensions, which allowed investors to stay in income drawdown after 75 but imposed heavy tax penalties on death, were introduced in 2006 but were only used by a few thousand people because of the restrictions on withdrawals they imposed.

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