As part of the new budget rules introduced in April 2015 the death benefits that pass to a partner, child or beneficiary when an income drawdown policy holder dies have been dramatically simplified and, perhaps more importantly, people inheriting someone’s pension fund are less likely to pay tax on it.
Previously somebody who inherited a pension fund faced the risk of a 55% tax charge. There are now many possible ways to inherit a pension fund without the need to pay any tax at all. In fact it could be considered that paying tax on an inherited pension pot has become voluntary.
Any potential tax liability will depend on the age that the original policy holder dies, with age 75 being the dividing line.
If the policy holder dies before the age of 75 then the person who inherits the pot can use the fund as they want, with no tax liability whatsoever. This means that while they can use the money to provide a pension or drawdown fund in their own name, if they wanted to take the whole amount as a lump sum, there is not a single penny to pay in tax.
If the policy holder dies aged 75 or older then the choices are a little more complex, but there are still ways to inherit the pension pot tax free.
If the pension fund is as yet untouched, and the person inheriting it wishes to keep it in a pension, then it is passed on tax free.
If the deceased has been in drawdown and has already taken their tax free cash, then if the person inheriting wishes to keep it in a pension, then they will inherit the entire remaining fund tax free.
You will only run the risk of paying tax on a pension pot inherited from somebody aged 75 or over if you choose to take it as a lump sum.
For the tax year 2015/16 a flat rate tax band of 45% will apply.
From April 2016 onwards this tax charge will be at the new owner's top (or "marginal") rate. So anyone who pays the basic rate of income tax will pay that rate, 20%, on money withdrawn from the pension. If the pension withdrawal boosts their income in that tax year to above the 40% threshold, they would pay 40% or even 45% on the amount above that level.