You probably cannot have escaped noticing that there have been some big changes to pensions recently and none more so since the 6th April 2015. The new “Pension Freedom” rules are long overdue and pension planning has suddenly become more attractive for many. For the first time in decades investors now want to put more money into pensions and many are now using their full annual allowance of £40,000 a year. However there are a few issues that you need to be aware of, one of which is the new death benefit rules.
Contact Martin Dodd on 01902 742221 or email him at [email protected] if you would like talk about money issues.
How do the new rules affect me?
The new pension rules regarding the taxation of pensions on death have improved dramatically, since the new rules came into effect in April 2015. Before the rules changed, if there were any remaining funds on death once you started to draw down your benefits (those using drawdown only and not those who purchased an annuity) you would suffer a punitive tax charge of 55% if the funds were withdrawn as a lump sum. Yes 55%! Quite literally one of the highest tax rates at the time in the United Kingdom. However, the rule changes are now much more favorable, but you may need to take some action to make sure that any surplus after your death goes to who you want it to go to and in the most tax efficient way as possible.
Defined Contribution (Money Purchase) pensions are usually outside of your estate for Inheritance Tax purposes before you start to take pension benefits.
So what happens on my death? If you die before the age of 75 and your remaining pension is paid out as a lump sum, the money will be free of income tax. If the money is paid out as an income it is also tax free whether it is paid out via an annuity or drawdown (both options may be available to a dependent or a nominated beneficiary). However if your pension nomination on death is to your husband or wife, the value of you pension will form part of your partners estate for Inheritance Tax. Is that something you really want to happen? Maybe your partner does not need your pension and could be diverted onto the next generation.
And what happens if I die on or after my age 75? If you die after the age of 75 and your remaining pension is paid out as a lump sum, the money will be subject to a tax charge of 45%. But that does not need to happen with careful planning. Getting the death benefit nomination drawn up correctly is now more important than ever.
The table below shows the potential different situations, should you pension money be invested in an old style pension arrangement, compared with a new modern arrangement.
Pension death benefits post age 75
|
|
| Actual outcome on death in old style pension | What could have been achieved if correct nomination made |
| Lump sum paid to the deceased client’s estate, minus 45% | Regular income paid to beneficiaries at marginal rate |
| The whole pension sum now sits in the estate and potentially subject to IHT | Money remains in the pension and outside of the estate |
| Beneficiaries remain restricted to their normal Lifetime Allowance | Beneficiaries could have access to inherited pension fund IN ADDITION TO their own Lifetime Allowance |
So why should I do anything now?
When you take out a pension or consolidate your pensions together, you should always make a death benefit nomination. Failure to do this may result in your pension fund not going to whom you intend and traditionally your husband/wife would be nominated.
However pensions can now be used to help pass wealth down through the generations efficiently especially if you have built up a substantial fund, so care needs to be taken to ensure that your death benefit nomination has been completed correctly, or your pension money could suffer a tax charge of 45% unnecessarily.
If your current pension does not have the facility to nominate all possible beneficiaries there may be a 45% tax charge. For example, if you nominate your husband or wife only as the beneficiary, there would be no 45% tax charge. However if there are still remaining funds on your husband or wife’s death and no further nomination had been made, the only option would be for the fund to paid out as a lump sum less the 45% tax charge. If your fund was still a reasonable size this could amount to a lot of money. But there is a very simple solution:
Instead of nominating your partner only (i.e. 100%), nominate your partner and your children. So your death benefit nomination could look something like this.
Partner 98%
Daughter 1%
Son 1%
Total 100%
By changing your death benefit nomination to include your children, they will have access to Flexi Access Drawdown and in the future it will be possible to change the nomination proportions. Without the nomination they would not be able to withdraw funds as income, only as a lump sum. So if your pension on the 2nd death was say £100,000, a tax charge of 45% would apply without the nomination. However with the nomination your children could choose how much if any income they wished to withdraw, therefore controlling how much tax they had to pay. This is very effective in not only controlling income tax, but also how wealth can pass from one generation to the next.
What do I need to do then?
You need to check if your current pension allows for “Nominee Flexi Access Drawdown”. If this option is not available consider whether it is time to look at changing your pension provider or transfer to a different contract to take advantage of the new rules. Without the flexibility to nominate beneficiaries in this way, your pension fund could suffer a 45% tax charge.
This article does not provide specific advice and you should always seek professional advice from a qualified adviser before making any decisions. Additionally, the article is based on our understanding of the tax laws at the time, which are subject to change by HMRC.
Contact Martin Dodd on 01902 742221 or email him at [email protected] if you would like talk about money issues.
Check out our other recent articles here
