As a planner, I’ve always liked pensions. However, it’s true… they are confusing and are not helped by the Government changing the rules all the time!
The latest pension changes – known in the industry as ‘pension reform’ – that came into place from April 2015 – means that everyone should be using them more and trying, at least a little, to understand them better.
This is because, thanks to the changes, pensions can now be passed down from generation to generation and this should be very attractive to lots of people.
So… I’m going to try to explain in simply terms how pensions can be used to pass wealth, tax efficiently, to the future generations – and keep more wealth in the family, rather than HMRC’s hands.
Tax and pensions
Before the new rules there were already good reasons for using pensions:
Tax relief on way in + tax-free growth =
greater pension pot and better lifestyle in retirement
These still remain positive planning reasons for using pensions but now, pensions are even better!
Passing down wealth
- The new rules will allow holders of flexible pensions (but not members of Defined Benefit plans) to nominate an individual to inherit their remaining pension fund.
- This can be anyone at any age and is no longer restricted to ‘dependents’.
- This means adult children (who may have long since left home and have families of their own) can now benefit and don’t have to wait until their own pension years to access the money.
- Beneficiaries can continue to have the advantages of tax-free investment returns and, potentially for some beneficiaries, tax-free withdrawals.
On and on…
- The ability to pass on and on pension wealth does not stop with one generation.
- The first nominated beneficiary can nominate their own successor who will take over the fund following their death.
- This will allow accumulated pension wealth to cascade down the generations, whilst continuing to enjoy the tax freedoms that the pension wrapper will provide.
TECHNICAL BIT: The Age 75 rule and income tax
- If the original member dies after age 75, any withdrawals will be taxed at the beneficiary’s marginal rate of Income Tax.
- If death occurs before age 75, the nominated beneficiary has a pot of money they can access at any time completely tax-free.
- In either case, the funds are outside the beneficiary’s estate for Inheritance Tax while they remain within the pension and will continue to enjoy tax-free growth.
Tax rate determined by age at last death
Each time a pension fund is inherited, the tax rate will be reset by the age at death of the last beneficiary / owner.
Mary, a widow, dies age 82 and had nominated her son Oliver to receive her pension. As Mary died after age 75, Oliver is taxable at his marginal rate on any income withdrawals. This could mean he pays 45% income tax (highest rate).
Sadly, Oliver dies age 65. He leaves the remaining fund to his daughter Simone. Simone can take withdrawals from her successor’s pension account tax-free as Oliver died before 75.
Review review review
The death benefit rules changes mean that for those looking to pass on any remaining pension funds on death to their family a review of the current plan is required.
This means revisiting existing death benefit nominations to ensure they continue to do what you want. Under the new rules, the scheme administrator cannot pay out a nominee’s pension drawdown if there’s an existing dependent (or an existing nomination in place that says something different).
Don’t forget that a nomination doesn’t have to be all or nothing. It’s possible to nominate a number of different beneficiaries and to perhaps skip a generation with some of the fund.
It’s also important to check that the current pension provider can allow what you want to do. Just because the legislation allows, doesn’t mean everyone will be able to in the contract they hold.
For the purposes of this blog and to keep it simple I have just referred to a ‘pension’. However, it should be noted that this ‘pension’ will need to be a Flexi Access Drawdown Pension. In addition, all of this type of planning relies on the existing pension arrangement being able to offer the nominees’ and successors’ drawdown accounts.
You will need financial advice to establish the correct pension contract / vehicle to use and some existing providers may be unable to provide this as an option.
Make sure you seek advice and #planitwell – call me on 07974 329864 for more information.