After contributing towards a pension for what often feels like a lifetime, we’re programmed to believe that we should live off our pension savings in retirement. But given 2015’s pension freedoms, for some people who want to pass on an inheritance, pensions are the last thing they should touch.
Published on 12 Nov 20186 minute read
Written by Mike Wardlaw
While many of the changes brought about under the new Freedom and Choice in Pensions Act 2015 were seen as directly related to pension planning, such as those concerning accessing a pension from the age of 55, a number of the new rules are in fact more about inter-generational planning. Imagine being able to provide a tax-free source of income for your family following your death. For many people, this would be their ultimate financial goal. Money left in your pension when you die does not form part of your estate and isn’t included when your Inheritance Tax bill is calculated*.
'Imagine being able to provide a tax-free source of income for your family following your death.'
If you die before age 75, the pension can be passed on to a beneficiary and they will never pay Income Tax on anything they take out of it, whether it’s a lump sum or regular income. If you die after 75, any income taken from that pension pot is taxed at the beneficiary’s marginal rate. For those people who are a member of a pension scheme, you can normally gain access to it from the age of age 55. But when you pass on your pension fund when you die, your beneficiary can access the fund at any age, ie before the age of 55.
These are very important rules if you put them into the context of your own family and wealth. Personally, I have found that a number of clients have rethought their whole financial planning strategy in light of these changes. If they are still taking an income in the form of pension drawdown, I ask them why and if they have thought about stopping it and using other sources of income. There is a strong argument for the money to be left in a pension scheme and passed on after death.
Between the 2009/10 and 2015/16 tax years, the amount of Inheritance Tax paid by the British public rose by 89%**, so it’s more important than ever to have a financial plan in place if you want to reduce this liability for your loved ones and increase the value of your estate. When people think about estate planning, they usually think the biggest asset they hold is their home but in recent years, this has not been the case. In 2015 for the first year ever, the value of money held in pensions was more than the value held in residential property. 40% of all wealth in the UK was held in pensions compared to 35% in residential properties (net of mortgages)***.
'In 2015 for the first year ever, the value of money held in pensions was more than the value held in residential property.'
If you decide that you want to fund your retirement outside your pension, there are a number of issues to consider. Your other savings and investments might not be enough to cover your living costs. When a client comes to me to discuss their retirement plans, I will always look at everything they have in addition to their pension and see what level of tax-efficient income they are able to take from ISAs and other savings accounts or investments. I will also take into consideration their current circumstances and future goals to establish if there is enough money available for them to live off without touching their pension.
When looking to pass on your pension, one of the most important things is to make sure that you have completed an expression of wish document and that it is up to date. This document sets out the details of your nominated beneficiary or beneficiaries. Although it’s not legally binding, your pension provider or trustees will use this information to help decide how your pension proceeds should be distributed. You should review this document regularly to ensure that your pension is still going to the person(s) that you want it to.
As with any element of estate planning, having a Will in place is vital. When deciding how to distribute your pension assets, the provider will consider your Will alongside the expression of wish document so it’s also really important to make sure this document is up to date too. Depending on the circumstances of the beneficiary, you may also want to think about setting up a pilot trust. For example, you might have an indication that the beneficiary you have nominated will get divorced or file for bankruptcy in the future – you probably won’t want a soon to be ex-spouse or accountants involved to be able to get a hold of your hard-earned pension savings!
The money from the pension, plus any other inheritance, would go into the trust upon your death. The trust is directed towards the beneficiary as an individual, but as it’s a legal trust, there can be no claim on it in the event of bankruptcy or divorce. However, there are tax implications of using a pilot trust and professional financial advice should be taken to ensure it’s suitable for your circumstances.
We currently have a tidal wave of wealth about to cascade through the generations. It can rip through in a very disorganised and destructive manner, or with careful planning and consideration it can flow through where and how you want it to. Our financial planners can work with you to ensure that your pension and your wealth are passed on in the most suitable and tax-efficient way possible for all parties.
If you want to know more about how we could help you pass on your pension, the first step is to book an initial consultation with our financial planners. They will be able to answer any questions you have and advise you on the best way to proceed.
*Please note these new rules are only relevant to defined contribution pensions and not to final salary pensions which have different rules.
** Source: Office for National Statistics - Inheritance tax: analysis of receipts 2015
*** Source: Office for National Statistics - Wealth Survey 2016
Advice in relation to tax, trusts and Inheritance Tax planning is not regulated by the Financial Conduct Authority, however, the products used in relation to trusts and to mitigate tax may be regulated.