We spend most of our working lives building up a pension and look forward to many more years enjoying it in retirement.
But what happens to the money after we die? The good news is that if you have an intact pension pot – as opposed to an annuity – your fund can survive your death and provide an income or nest egg for your loved ones to enjoy, long after you are gone.
Pensions aren’t counted as part of your estate for inheritance tax purposes. Before pension freedoms there was a hefty 55% pensions death tax, but since 2016 it has been possible to pass a pension on tax free.
However, as is usual where tax is concerned, things are not quite that simple.
If you die before the age of 75 and have commenced a drawdown pension, your beneficiaries will pay no tax on any pension income and any lump sum paid within 2 years of death. This means that wealth built up in a pension can be passed on as part of their inheritance without losing the tax shelter or any tax charge, regardless of whether withdrawals have been made.
Once you turn 75th birthday your pension assets become taxable, but only at the marginal rate of income tax.
You can nominate anyone to inherit your remaining pension fund as a drawdown account, which allows them to dip into the pension pot they inherit as and when they want. It is even possible to nominate more than one beneficiary, and decide in what proportion you want each person to benefit.
But to take advantage of this opportunity to pass on your pension in a tax efficient way, there are a few preparations to make.
- Check that your pension scheme allows you to pass your pension on in this way. Older styles of pension schemes may not allow your beneficiaries to inherit your fund as a drawdown account. If you’re in a final-salary pension that pays out an income, and you want to pass on your money to a beneficiary when you die, you may need to transfer your pot into a more modern pension that does. This is not something to be done lightly. Valuable guarantees sometimes apply to older pensions. Providing for your loved ones after you have gone could mean reduced benefits for you, so speaking to our experts is essential.
- With effect from 6 April 2011 though, (and subject to the rules of the scheme permitting it) there is no longer a maximum age by which members of registered pension schemes must annuitise or otherwise secure their benefits this means that a tax free cash sum can now be taken whenever benefits are taken, even if this is after age 75.
- Give up to date details of the nominated beneficiaries of your pension fund to your provider. Your will is a vital part of planning your estate, but it does not cover your pension so you will need to use an expression of wish form to tell your provider how your money should be used when you are no longer able to spend it yourself. Pension providers should allow you to nominate your beneficiaries when you start paying into your pension, or change them once you have started paying. You may be able to do it online.
Leaving wealth to loved ones, not the taxman
You may want to leave your pension to your partner, but you can name any number of beneficiaries. However, you may want to be careful how you do it. Leave your pension to your working age children, once you have turned 75 and they pay their highest rate of income tax on the pension withdrawal. Leave it to grandchildren and they can make the most of personal income tax allowance – so, if they have no other sources of income, they can each withdraw up to £12,570 from your pension tax-free, every year.
Your beneficiaries can inherit your pension rather than receive a lump sum. This means your pension remains outside of your estate for inheritance tax purposes, your beneficiary is then able to pass on any residual fund to a successor and this can continue until the fund is exhausted. This means you are able to pass money down the generations without a tax charge.
You can also nominate a trust rather than individuals in your expression of wish form.
Getting some expert help
The world of pensions is complex enough just looking at what’s best for you – let alone your family.
At Continuum we can help guide you through the maze of rules and regulations and ensure more of your pension goes to those you care about when you no longer need it yourself. To find out more, call us today.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable retirement strategy, you should seek independent financial advice before embarking on any course of action.
The value of investments can fall as well as rise and you may get back less than you invested.
The Financial conduct authority does not regulate will writing, taxation and trust advice.