While many believe ASP now only has limited use Mike Morrison believes there are ways around the tax charges
As we know, for many people the two largest assets that they will own will be their house and their pension fund. Both can be good investments, both can be used to generate income but it is on death where the similarity ends. A house is relatively easy to pass on as an inheritance - a pension is not!
Before 1995 the only option available under most pension schemes was annuity purchase with its limited options to pass money on, namely guarantee periods and/or the provision of a spouse's pension.
In 1995 income drawdown was introduced which meant that annuity purchase could be deferred to age 75 and it was only with A-Day and the introduction of alternatively secured pensions (ASP) that annuity purchase became no longer compulsory.
Benefits of ASP
ASP seemed to offer those who did not need income the chance to leave their pension scheme to grow and then pass on to family members on death. Post A-Day there appeared to be no real issue other than how inheritance tax would be applied to the residual ASP funds. This optimism was short lived.
The pre Budget Report in December 2006 was expected to include the HM Treasury's up to date thinking on the subject and indeed it did. Rather than not needing to draw any income, a minimum income of between 65% and 90% of GAD rates was introduced.
Any residue on second death or first death without any dependants (the transfer lump sum death benefit) would then become an unauthorised payment and subject to a whole raft of potential tax charges, namely:
- Unauthorised payment charge of 40%
- Unauthorised payment surcharge of 15%
- Scheme sanction charge of 15%
- IHT of 40% could also still apply
- There could also be a scheme deregistration charge of 40%.
Between the pre Budget Report and the Budget on 21 March 2007 there was considerable lobbying to change the Treasury's view and it did appear from some reports that there was some hope of change.
However, the Budget brought very little change other than a reduction in the amount of minimum income to 55% of the GAD rate and some clarification of how inheritance tax would be levied against the fund. The key point is that the legislation is very firmly structured to dissuade any attempt to pass on money to beneficiaries' pension schemes after death by keeping the transfer lump sum death benefit as an unauthorised payment.
So from a planning perspective the role of ASP seems to have changed drastically.
Dealing with the changes
In such circumstances it would appear to be logical to attempt to minimise the amount of the fund that is likely to be left and subject to the tax charge. In order to achieve this specific planning might be required.
Obviously one option might be to just spend the pension fund as quickly as possible but it is probably possible to add a little more subtlety to this. It might be possible to draw more income than is specifically needed and then this excess income could either be invested for the direct benefit of the drawdown client or it could be passed in a third party pension contribution to a spouse or children.
As an alternative the extra income taken could be invested into another investment vehicle which has a more beneficial inheritance tax regime than ASP. This could be into an investment bond in a trust, a whole of life policy or even into a portfolio of AIM stocks which would not be subject to IHT on death.
The key thing is to make sure that the money is moved into an investment where the potential tax charge is less than 82%.
It is also important to realise that the ASP tax charges are only chargeable in the absence of a dependant. So for a situation, say, where there is a husband with a younger wife, it is likely that she would live longer than him and therefore the period of time that ASP could continue could be considerable.
So where does that leave payment of the remaining fund?
Well it can be paid to a charity without any tax being due or it can be paid as an unauthorised payment. It is down to providers to make a decision as to what options they will offer.
If a scheme pays unauthorised payments that exceed 25% of the value of the scheme in a given year, then it is possible that HMRC will levy an extra discretionary tax charge. This might be the deciding factor in the choice to make such payments - so a large personal pension scheme might be able to but individual policies or small schemes might not.
All this confusion could have been avoided if there was recognition that it would be good to allow pension funds to be inherited, perhaps just by applying a flat tax rate to the remaining fund to compensate for the tax relief given.
The Treasury's view is that tax relief is given to pension contributions on the basis that an annuity must be purchased eventually. This was perhaps more palatable when annuity rates were higher but when there are higher investment returns available this might not be an attractive option.
An alternative view would allow pensions to be inherited in the same way as the family home and could be engineered to be tax neutral and may well encourage pension planning.
I suspect that this is a subject that will not go away!
Industry Voice: Scottish Widows pension expert Robert Cochran and economist Andrew Scott discuss the future of employment and income, in episode three of Scottish Widows' podcast series.
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