‘Pensions Freedom’ has now been in place for well over 12 months. Changes to legislation have undoubtedly provided more choice along with potential benefits, depending on how an individual plans to use their pension fund.
The most significant change the legislation brought about was in relation to death benefits. Here we take a closer look at death benefits, how the changes apply in different scenarios and the more technical aspects of nominating beneficiaries.
The New Rules
As of 6 April 2015 the 55% death tax payable on crystallised drawdown pension pots was scrapped. Now if a pension holder dies before the age of 75, they can pass their pension pot on to their chosen beneficiaries without any tax implications (subject to available lifetime allowance).
If the pension holder is over the age of 75 upon death withdrawals from the inherited pension, whether on a regular basis or as a lump sum, will be taxed at the recipient’s relevant income tax rate.
As pensions are generally written under Trust they do not usually form part of an individual’s estate for Inheritance Tax (IHT) purposes meaning the new rules provide an advantageous route for passing on wealth to the next generation and beyond.
Any monies withdrawn from the inherited pension pot and not spent will form part of the beneficiary’s estate for Inheritance Tax purposes. Likewise where monies are withdrawn and retained in the hands of the investor, there may be tax implications. Careful consideration must be given to withdrawals from inherited pension pots, in particular the intended destination of these monies.
The Taxation of Pensions Act 2014 has also allowed greater choice over who is eligible to be a beneficiary. The pension holder can nominate as many people as they wish, who they wish and in whatever proportions they desire. Although nominations are not binding they provide the Trustees of the scheme with a clear direction of your wishes. Where no nomination is made the Trustees will use their own discretion, which may mean your pension monies are not directed to your intended beneficiaries.
The new rules also allow the nominated beneficiary to pass on any unused drawdown funds on death to their own nominated beneficiary, known as a ‘successor’. The same rules apply in terms of taxation of the death benefits however the relevant age will now be based on the beneficiary rather than the original member. The only requirement is that the inherited monies must be in a flexi-access drawdown fund upon the beneficiary’s death.
In the majority of cases most people will nominate their spouse / civil partner but this may not always produce the ‘best overall outcome’. Clients should expect their adviser to review their nominations at their annual review to ensure they remain appropriate and in line with their wishes.
Applying The Rules in Practice
At the time of writing a nomination, a client will not know the financial circumstances of their spouse or the financial and personal circumstances of their children on death. In order to maintain control and flexibility clients may wish to write a nomination stating 99% of the benefits should be allocated to their spouse and 1% to their children. Naming the children on the form means that the trustees may be able to vary the distribution of pension benefits on first death provided the nomination is accompanied by appropriate wording.
An example of where this might have value is where death occurs prior to age 75 and the surviving spouse does not need the money at the point of death. The trustees may then be able to make a tax free lump sum to the children if their personal circumstances deem that appropriate.
The wording that goes alongside this nomination is critical to ensure that the ultimate benefit gets to the right people, at the right time and in the most tax efficient way. It is therefore extremely important that advice is taken at the point a nomination is put in place or reviewed.
Am I Eligible?
Despite the changes having passed into legislation in 2015, there is no legal requirement for providers to facilitate this legislation. It is therefore a possibility that your pension product will not allow for all of the new flexibilities. In this eventuality, upon the plan holder’s death, an income option to the nominated individual might not be available with the only option being the provision of a lump sum death benefit. This could have a number of tax implications, as described above.
If you are unsure about whether your current arrangements allow you to maximise the new rules you should seek professional advice.
As with all of the changes afforded by ‘pension freedoms’, the best route to take to maximise your pension pot will very much depend upon personal circumstances and ultimately what you want to achieve from your pension savings. For further advice on this highly technical area, please contact our team of financial advisers.