Making the most of your pension Part 2

pension freedomsPension freedoms and death benefit

You don’t have to try and spend it all. Passing on the wealth in your pension pot to younger generations has become simpler, thanks to pension freedoms.

The Government needs to encourage us all to save for our pensions. Although, as we have seen in the first part of this two-part article, there are still limits on how much we can save into our pension pots, there are also ways to help boost them.

Your pension pot represents a large proportion of your personal wealth. But it does have a few strings attached. It used to be that you could only pass on your pension savings to your  heirs without being taxed if you died before 75 and had not touched the funds.

If you had drawn on your retirement pot, or were over 75, 55% of the fund would be subjected to a punitive ‘death tax’.

Now, thanks to pension freedoms, an entire pension pot can pass down to beneficiaries, tax free, or at least at a less frightening tax rate.

A pension can help avoid inheritance tax

Now, if the pension fund holder dies before 75, a beneficiary can inherit a lump sum, or income from drawdown, tax free. If the death is after their 75th birthday, the pension pot that is passed on as part of an inheritance will be taxed at the recipient’s marginal rate.

This makes a big difference to estate planning. Under the old rules, there was an incentive to running down assets in the pension fund after 75. Now, it might make more sense to run down other assets first, such as ISAs which are subject to inheritance tax.

But as always with tax matters things are not quite as simple as they might at first appear.

Do you have the right kind of pension?

The new freedom does not apply to all types of pension. Income drawdown policies, such as Self Invested Personal Pensions (SIPPs), capped drawdown or flexi-access drawdown can use the new rules. Defined benefit, or final salary, arrangements are not covered.

Annuity policies where the policyholder has chosen value or capital protection, which comes at a cost, will be covered by the death benefit changes. Otherwise, any residual funds left in an annuity pot pass to the insurer.

Who can benefit?

It used to be spouses and dependants were the only people who could enjoy the pot — now it’s anyone you nominate.

What’s more, they can decide how the money is paid.

Before freedoms were introduced, pension schemes simply paid out death benefits at the trustees’ discretion. This would be based on the nomination or expression of wish form completed by the pension holder.

A cheque would be sent. This would be a lump sum which could complicate income tax for the recipient.

The new rules are very different. Although the expression of wish form is still needed, the money can stay in a pension scheme where it continues to have tax advantages. With flexi-access drawdown, the beneficiary can take as much or as little income as they want from the pot. If income is not needed, the fund can be left in a pension scheme and the beneficiary can nominate their own “successor” beneficiary. Their successors will be able to designate any residual benefits to do the same.

If the pension holder was under 75 when they died, then the income can be paid tax-free to the beneficiary as long as the plan was designated for drawdown within two years of death. If the pension holder was over 75 at death, then the income will be taxed at the beneficiary’s marginal rate of tax.

This sounds better and fairer for all – but most policies drawn up before pension freedoms came into force in 2015 still only offer death benefits as a lump sum.

This could lead to income tax charges.  Someone earning £30,000 a year, who receives £100,000 as a lump sum, would see their tax bill increased by £41,800.

Getting help

You will probably want any money remaining in your pension pot to go to your loved ones rather than the taxman. So you may want to ensure that your beneficiaries can take advantage of the new rules.

There may be ways to do this. For example, those with deferred defined benefit pensions are currently outside the new rules. They might want to think about transferring to a SIPP, to increase the potential death benefits and reduce tax liabilities.

To find out more about the situation with your pension plan, and whether you should consider making any changes, please contact the Continuum team where one of our professional team will be happy to help.


A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.

Levels and basis of reliefs from taxation are subject to change

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