The mere mention of the word Pension for many people creates an instant sense of boredom, complexity and jargon! A minefield of rules and regulations as well as being told by everyone from government to our parents that we are not setting enough aside for retirement, is usually “the nail in the coffin” to the conversation!
Indeed, the historical combination of very limited options on how you draw your pension, and that it ends on you, or your dependants death meant that as a financial planning product it had limited appeal. If you paid into a pension for many years and you died early into your retirement, your pension provider often got a windfall. Hardly appealing!
From April 2015 however, a quiet revolution has been occurring in the dull world of Pensions. The government realised it needed to make drawing pensions more attractive so introduced legislation that would allow hard earned pension funds to pass from one generation to another and would not limit beneficiaries to solely being a spouse or dependants. For individuals who have significant pension funds and are unlikely to spend all the funds in later, this has now opened up a number of planning opportunities.
Whilst there are lots of rules and regulations about passing your pension from one generation to the next the basic principles are as follows:
- When the person dies before age 75 the benefits can be paid as a lump sum or as a drawdown pension to any beneficiary tax-free, irrespective of whether they derived from uncrystallised or crystallised monies. In other words, whether the person is drawing their pension or not before aged 75, if they die early they can pass it on to anyone.
- When the person dies after age 75 the benefits can be drawn down or paid as a lump sum taxed at the beneficiary’s marginal rate. In other words, when the person dies after the age of 75 they can still pass the pension on to anyone but they will pay income tax on the proceeds.
- On death after age 75 the benefits can be paid as a lump sum to a trust with a 45% tax charge. So even if the person has no immediate beneficiaries the fund is not lost.
From an estate planning perspective this starts to look very attractive as Pension funds do not generally form part of your estate for Inheritance Tax purposes and continue to enjoy tax free growth. Contributions to pensions also attract tax relief at your highest marginal rate up to £40k per annum and individuals can “mop up” the previous three years contributions if they have not fully used their allowances.
There are three things to carefully consider though, when looking beyond the headlines of the 2015 Pension Freedoms. Firstly the rules do not apply to all types of pension scheme and some providers have not updated their products to allow for these flexibilities. Employer sponsored schemes that pay out a guaranteed percentage of salary at retirement do not qualify.
Secondly, the government places a cap or “Life Time Allowance” on how much pension an individual can build up before additional taxation maybe incurred. The amount is currently £1,073,100 and this has been frozen until April 2026. The Life time Allowance does not stop an individual taking advantage of pension freedoms but careful planning is needed to minimise its impact from a tax perspective for funds in excess of the Lifetime Allowance. The current allowance figure has moved around considerably over the years, both up and down, so again care is needed.
Thirdly using the flexible pension arrangements are just one way of passing your assets efficiently to the next generation, but it’s likely and indeed should fit into a wider plan. That plan will consider risk appetite, timing and control of asset and income distribution to meet your objectives as well as minimise tax liabilities; so consider all options.
So in summary, pensions whilst remaining somewhat dull and complex, since April 2015 have found a new purpose in terms of wealth transfer. The new rules do not apply to all schemes, so it’s important to check, but those that do offer a whole range of planning options for individuals and families. Taking professional advice early in the process will also help you maximise the opportunity and avoid mistakes, which with pension Planning are often difficult to unravel!
The Penny Group
The information in this article was written for purely informational purposes, do not take any action without speaking to us in the first instance. We can refer you to our partner financial firm, The Penny Group.