With the introduction of pension freedoms in 2015, we now have a range of options when deciding how to fund our retirement. But few of us stop to consider what might happen on our death: retirement itself seems far enough away!
Under the previous regulations, only one dependant of the pension plan holder could inherit a drawdown pension on the plan holder’s death. Commonly known as a “widow’s pension”, widowers, civil partners and a single named child could also inherit, putting the plan holder in a difficult position if they had more than one child.
Many still believe that this is the only way their pension savings can be passed on in the event of their death. However, alongside the more familiar changes to the retirement regime, the reforms heralded significant changes in how pension death benefits are taxed, bringing with them new inheritance planning opportunities.
Passing on your wealth
Since April 2015 it has been possible for the plan holder to pass their pension on to any nominee – or a number of nominees – 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 assets for Inheritance Tax (IHT) purposes. And as long as they remain within the wrapper they retain their full tax advantages until they are 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 subject to the beneficiaries’ personal tax position (ie. taking into account other sources of income).
How might your dependants benefit?
The example given below is a simplified illustration and only a guide to what might be achieved with careful financial planning.
However, it is 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 and the tax benefits are lost.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
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 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.
Please contact me if you would like to discuss the pension death benefit rules and explore whether and how you and your loved ones could benefit from them. We can review your current arrangements to see if they offer the flexibility required and explore alternative arrangements if necessary.