What is pension death tax, what is going to change and how will it affect you?

George Osborne has said the Tories will scrap pension death tax next year, but what does that mean to you?

The Chancellor has announced that the 55 per cent tax penalty will be scrapped (Getty Creative)

What is the pension death tax?

It's what the Government snatches from people's pensions if they die after the age of 75 and whose dependants are 23 or older. The rate charged is at 55 per cent; in other words the bulk of the pension pot.

So what's changing?

The Chancellor has announced that the 55 per cent tax penalty will be scrapped. It means pensions will be allowed to be passed on tax-free. The tax will also be scrapped on pension pots for those aged under 75. At present people under that age can only pass on their pension fund tax-free if it has not been touched.

Why has this been announced now?

To gain some positive headlines during the Tory conference to offset Ukip defections and other concerns. The change apparently wasn't due to be revealed until the Autumn Statement, in December. The measure will apply to all payments made from April 2015.

Is it good news?

Yes say experts. “This is good news for ordinary savers, who often will not be able to afford to leave their pension funds untouched until age 75,” says former Treasury adviser Ros Altmann. “The existing rules disproportionately benefitted the wealthiest, but now every pension saver, regardless of their means, will know that their hard-earned savings can pass on to their loved ones without the current unfair tax penalty.”

Alan Higham, retirement director at Fidelity Worldwide Investment, says: “This was a poorly understood area which tripped up a number of people who inadvertently caused their loved ones to pay huge sums of tax on their death soon after retirement. People will no longer have to choose between taking some tax free cash now or putting it off until later for fear of triggering penal death duties.”

However, the move is likely to be a mixed blessing as it will lessen the attraction of annuities, reckons Tom McPhail, head of pensions research at Hargreaves Lansdown: “The changes will encourage investors to take the maximum possible advantage of their pension contribution allowances, which is certainly a good thing. However it is likely to significantly boost demand for income drawdown in retirement and to diminish the relative attraction of annuities.“

What should I do now?

Older people should make sure their will is up-to-date. “When you die, most pension funds pay any remaining money to your beneficiaries according to your own expression of wishes,” points out Mr Higham. “It is important to make sure all your pension funds have been notified of who you would like to benefit. Everyone should consider their choices again as a result of these changes.”

Independent Partners; get a free factsheet on 2014 pension rules changes from Hargreaves Lansdown