Savers will be able to pass on money in their pension pot tax free to their children and grandchildren upon their death, after Chancellor George Osborne announced that he will abolish a 55% penalty tax for some groups.

The measure, announced at the Conservative Party conference in Birmingham, will apply from April 2015 and is expected to benefit the families of hundreds of thousands of people to the tune of a total £150 million each year.

The key winners in the policy change will be those who are beneficiaries of a defined pension fund left to them by someone aged under 75 whose pension was already in a drawdown account.

Beneficiaries of pension funds left to them by someone aged 75 or over will also now be able to take the funds through drawdown at their marginal tax rate – previously this was only available to dependants.

The move is the latest in a number of reforms to overhaul the pensions system, with most changes to take effect from April 2015.

But MoneySavingExpert.com creator Martin Lewis warns it may mean some people become too afraid to touch their pension savings, as knowing the income won't be taxed will give them an even greater motivation to save it for their children. See his Cancelling the 55% tax on unused pension pots could be a disaster for many older people blog post for more.

Martin Lewis
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What exactly's changing?

Osborne's announcement only affects those with a defined contribution pension, which is where you pay contributions into a pot and the amount you get depends on how much has been paid in, how long you've been paying in and how well the investment has done.

The rules on passing on defined benefit pensions when you die, which is where the amount of pension you will get is known at the time that you join, depends on the individual scheme.

Here's what's happening from April 2015 for those passing on defined contribution pensions:

  • Die aged 75 or older and pension is already in a drawdown account: Can be passed on as a lump sum to any beneficiary taxed at 45%, or can be taken through drawdown by any beneficiary at their marginal tax rate.

  • Die aged 75 or older and pension is untouched: Can be passed on as a lump sum to any beneficiary taxed at 45%, or can be taken through drawdown by any beneficiary at their marginal tax rate.

  • Die under 75 and pension is in drawdown: Can be passed on to any beneficiary as a lump sum or taken through drawdown tax free.

  • Die under 75 and pension is untouched: There's no change here – it can still be passed on to any beneficiary tax free.

The Government also wants to charge lump-sum payments made to beneficiaries of those who die aged 75 or above at the marginal tax rate, rather than at the 45% flat rate. It says it will "engage" with the pension industry in order to put this in place for 2016-17.

Here's what the current rules are:

  • Die aged 75 or older and pension is already in drawdown: Can be passed on as a lump sum to any beneficiary taxed at 55%. Or a dependant, which includes a spouse/civil partner or child under the age of 23, can also draw down on it at their marginal tax rate.

  • Die aged 75 or older and pension is untouched: Can be passed on as a lump sum to any beneficiary taxed at 55%. Or a dependant, which includes a spouse/civil partner or child under the age of 23, can also draw down on it at their marginal tax rate.

  • Die under 75 and pension is in drawdown: Can be passed on as a lump sum to any beneficiary taxed at 55%. Or a dependant, which includes a spouse/civil partner or child under the age of 23, can also draw down on it at their marginal tax rate.

  • Die under 75 and pension is untouched: Can be passed on to any beneficiary tax free.
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