There’s a range of options when it comes to deciding how to fund retirement, but few of us stop to think about what might happen to pension savings in the event of death.
Alongside the more familiar changes to retirement choices that happened back in 2015, ‘Pension Freedoms’ heralded significant changes in how pension death benefits are taxed; bringing with them new inheritance-planning opportunities.
Passing on wealth
Since April 2015 it has been possible for the plan holder to pass their pension on to any nominee(s) through something called Nominee Flexi-Access Drawdown. Further, when the nominee dies, a successor – or successors – can also inherit a drawdown pension through a Successor Flexi-Access Drawdown.
In turn, each nominee or successor can pass the assets on to other nominees or successors, retaining the tax efficiency of the plan through multiple generations.
The key benefit lies in retaining the assets within a pension wrapper: in this way they fall outside of the plan holder’s estate for Inheritance Tax (IHT) purposes.
As long as they remain within the wrapper they stay tax efficient in most cases until they’re needed by the nominee or successor.
If the plan holder – or a nominee or a successor – dies before the age of 75, not only are the assets passed on free of IHT, but the drawdowns are paid out free of income tax.
If they die after the age of 75, the assets are still excluded from the estate for IHT purposes, but any lump sums or income drawdowns are treated as income and are subject to the beneficiaries’ own marginal rate of tax (ie. taking into account other sources of income).
How might your dependents benefit?
The example given below is a simplified illustration and only a guide to what might be achieved with careful financial planning.
However, it’s important to note that most of the existing pension plans were set up before the new regulations came into force and may not have the flexibility to establish Nominee or Successor Flexi-Access Drawdown accounts.
Instead, the pension provider will pay out the full value of the fund in cash on the death of the plan holder. In that situation, the assets count towards the total estate for IHT purposes.
The pension family tree
A family comprises a husband and wife, their two children who in turn have two children each (four grandchildren in total).
The husband dies aged 76 with £500,000 remaining in his pension fund.
The wife inherits a Nominee Flexi-Access Drawdown plan. As her husband died after reaching the age of 75, any withdrawals are taxable as income. The wife dies aged 74 and with £450,000 remaining in the plan.
The two children each inherit half of this (£225,000) through Successor Flexi-Access Drawdown. Withdrawals are tax free as the mother died before age 75. However, both children die in their 60s without accessing their plans. As they also died before reaching 75, each residual pension fund passes tax free to the grandchildren.
Each grandchild inherits a Successor Flexi-Access Drawdown pot of £112,500 and enjoys tax-free withdrawals.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
Please contact us if you’d like to discuss the rules and explore whether and how you and your loved ones could benefit from them.