Death and pensions; both topics that most of us will do almost anything to avoid discussing.
So, bear with us in this article as we talk about both, at the same time!
You spend years working hard to build up your pension, and hope it will provide you with everything you need in retirement. But, what if you don’t get there, what happens to your pension then? On a brighter note, if you live to a ripe old age, but still have money in your pension when you depart, where does it go then?
Let’s try and answer some of those questions.
Much depends on the type of pension you have and when you die. In this piece we’ll be talking about Money Purchase pensions, which include:
- Personal Pensions (including Group Personal Pensions)
- Auto enrolment
- Stakeholder pensions
- Self-Invested Personal Pensions
- Small Self-Administered Schemes (SSAS)
- Flexi-Access Drawdown (formerly known as Income Drawdown)
Your provider will ask you to nominate who will benefit from your pension after your death. You can choose any individual, irrespective of whether they are a family member, or organisation, including charities.
You can also choose a combination of individuals or organisations.
Those people who you choose to benefit from your pension have three options when you die. These can be briefly summarised as:
A lump sum: If you pass away before the age of 75, and your beneficiaries select their preferred option within two years of your death, they can receive your pension as a tax-free lump sum. This assumes that if you have yet to crystallise your pension, by withdrawing money, the value is below the Lifetime Allowance currently £1.
If you die after 75, your beneficiaries would pay tax on any lump sum at their marginal rate.
Drawdown: Your beneficiary may decide to take an income from the pension pot via a Drawdown arrangement. Again, if you die before the age of 75 and they decide on their preferred option within two years of your death, the income they receive will be tax-free, no matter how old they are.
If you’re over 75 when you die, the income paid to your beneficiaries will be added to their other income and taxed accordingly.
Annuity: Your beneficiary may require an income, but prefer the certainty provided by an Annuity.
Again, if you die before the age of 75 and they decide on their preferred option within two years of your death, the income they receive will be tax-free, no matter how old they are.
If you’re over 75 when you die, the income paid to your beneficiaries will be added to their other income and taxed accordingly.
Inheritance Tax
Whilst income tax may be charged on your pension when you die, Inheritance Tax (IHT) won’t be.
That’s because money held in pensions is outside the IHT net. A fact which can be used to your advantage if reducing the amount of IHT payable when you die is one of your key financial objectives.
A word of warning
Not every pension provider will allow each choice.
If you know your beneficiaries will prefer a particular option when you die, it would be sensible to check that your provider can accommodate their wishes.
How have the new pension rules changed our thinking?
The pension death benefit rules have changes considerably over the past few years, leading advisers and planners to change much of their thinking.
For example:
Spending savings or investments before pensions: Money held in pensions is outside of your estate for IHT purposes. Other savings and investments aren’t. Furthermore, pensions can now be passed on to younger generations in ways which were not previously possible.
These changes turn conventional wisdom, of spending money in pensions first, leaving savings and investments intact, on its head. In some cases it can, potentially, be more IHT efficient to take an income from your savings and investments before your pension.
Leaving money in the pension wrapper: The new rules allow money to be passed on while remaining in a tax-efficient pension wrapper. Furthermore, your beneficiaries don’t have to wait until they are 55 to access it.
This wasn’t previously the case and is a significant advantage of the new rules.
Skip a generation: Traditionally, pension funds were left to the surviving spouse and then to their children. However, the new rules mean other options become available and it may be more tax advantageous to skip a generation or two. Of course, this can only be done when the surviving spouse has sufficient income.
Think ahead
It’s tempting to think that none of this will apply to you for years to come.
And hopefully that’s true.
However, no one knows what the future holds, and you need to make sure that the needs of your beneficiaries are catered for in every eventuality, no matter how unpalatable that might be.
Planning ahead can ensure that the right money, is put in the right hands, at the right time; with as little as possible going to the government in the form of IHT.
We are here to help. If you have questions, or would like to better understand the options you have for your pensions after your death please get in touch, we’d love to hear from you.
