There have been many changes in the pensions world recently, the most important being the tax treatment of pension death benefits.
Prior to April 2015, a ‘death’ tax of 55% was applied to all pension funds before they were passed on to your estate. In effect, a pension fund of £600,000 would have been reduced to a value of £270,000 before being passed on.
This tax has now been removed so any funds accrued within a personal pension will, in most circumstances, be passed onto beneficiaries tax free.
Pensions are typically structured within a master trust, and as a result they fall outside of your estate and subsequently any Inheritance Tax (IHT) calculations.
As the rate of IHT in the UK is 40%, our previous advice to clients was to draw on their pension fund in the first instance, leaving other savings and investments in place. This made financial sense as the pension would be subject to a higher rate of tax on death (55% compared to 40% for other assets).
However, following the legislation changes it was all change! We have subsequently turned our advice on its head and now recommend any pension funds are left intact where possible. This leaves your beneficiaries in a much better position financially, given your overall estate would be subject to less tax.
In summary, the new tax treatment is as follows:
§ On death before age 75, benefits can now be paid to any beneficiary tax-free, irrespective of whether these benefits are paid as a lump sum or income
§ On death after age 75, the benefits can be drawn as an income or a lump sum at the beneficiary’s marginal rate of income tax. Given the flexibility pensions now offer, it would be possible to structure any income requirements either within your beneficiary’s personal allowance or up to the basic rate tax threshold, minimising the level of tax paid.
In addition to the significantly improved tax-treatment, the Government has removed the restriction that only an income can be paid to a ‘dependant’, with the new rules allowing for any beneficiary to elect for either an income or a lump sum payment. An obvious advantage is that any remaining funds following the death of the first beneficiary, can be passed on to further nominated beneficiaries. Importantly, this allows for pension funds to be preserved through multiple generations until exhausted.
Used correctly, pensions can therefore be used as a hugely effective estate planning vehicle.
With this increased flexibility and improved tax treatment, it is now essential for the nomination of beneficiaries which sits alongside a pension, to be reviewed and kept up to date.
Whilst this is a topic most of us don’t want to think about, it’s important your options are considered closely in conjunction with the new regime. You should also check that your pension funds are held with a provider whose trust deed will allow you to make full use of these additional options.
This is a complex area and you should take advice to ensure your retirement planning is fully aligned with your estate planning.
Please do contact me on 07525 987397 or via email.