Pension Freedom Rules: Article Three

Under the new Pension Freedom Rules, what is the position on your death?

The new rules allow you to leave whatever remains in your ‘individual’ pension pot to whomever you like, not just a spouse or dependent. However, this does not apply to any annuity you may have purchased, any entitlement you may have under a final salary pension scheme, nor to any benefits you may have under an employers’ money purchase scheme, where your pension pot has been converted to an annuity.

If being able to control and leave this legacy is important to you, you may need to move your pension pot from your employers’ pension arrangement to a contract in your own name, albeit you might forsake other benefits and guarantees to achieve this.

  • If you are under the age of 75 at date of death:
    • If paid to your chosen beneficiaries, they receive the pension pot free of Income Tax and Inheritance Tax, no matter how they draw it, as long as this is done within 2 years of the date of death. There may be subsequent tax implications upon the beneficiaries if they do not use the pot wisely.**
  • If you are aged 75 or over at the date of death, the tax position is dependent upon how the pension pot is taken by the beneficiaries:
    • If they take it all as a Lump Sum
      • Then under current legislation, they will be subject to a 45% Income Tax charge but there will be no Inheritance Tax to pay. There is ‘intention’ on the part of the Government to change this to the beneficiary’s marginal rate of tax in the next tax year but this has not yet been confirmed.
    • If they choose to use the proceeds to buy an annuity or they choose to continue with drawdown;
      • Then the income will be taxed at the beneficiary’s marginal rate under Pay As You Earn.

** We mentioned above, the subsequent taxation risk to the beneficiaries. As with the original member, if they take all of the fund as cash, then they face all of the risks the original member would have done had they taken the fund as cash, (as explained in our previous article), plus there is strong evidence that there is an increased risk of them being profligate in spending the capital, as it was not their hard work that secured the benefit in the first place.

As your pension pot was hard earned during your lifetime, you may wish to ensure your heirs can benefit from it, whilst also protecting this legacy from the risks of 2nd and 3rdgeneration Inheritance Tax, profligacy, the bankruptcy or divorce of any of your beneficiaries or Local Authority access toward the funding of Long Term Care costs of any beneficiary. This can be achieved by having the residual pension pot paid into a suitable Trust

If the member dies before age 75 and it is paid into trust instead of directly to beneficiaries, it helps protect the legacy against profligacy, 2nd and 3rd generation Inheritance Tax, the bankruptcy or divorce of any of your beneficiaries, Local Authority access toward the funding of Long Term Care costs of any beneficiary.

However, these benefits need to be balanced against the possibility of less advantageous tax treatment once in the trust. Most of the tax disadvantages can be mitigated against through prudent planning, to the point the question of whether or not to pay the pension into trust, is driven by establishing which compromise best serves your objectives as a whole.

Whilst the changes are advantageous to many, it is vital that you consider your situation in the round, as there are many pitfalls with taking action in isolation. Therefore, in our opinion, it is vital that you secure good qualified independent advice.

Written by
Karl Lavery