The changes to pensions in recent years have turned tax and estate planning on its head. Partner Ross Brown explores the issues in relation to pensions and succession planning.
Previously, people would draw down their pension and build up their savings so they had something to pass onto their children. OK, there may be Inheritance Tax to pay, but this was better than the 55% tax charge which would arise if they passed on their pension as a lump sum.
Now things are different. Pensions are an integral and crucial part of tax and succession planning. If a person dies before age 75, the pension can either be transferred as a lump sum or as a pension tax-free.
If a person dies after age 75, the pension can only be transferred as a pension rather than as a lump sum, but the beneficiaries will only have to pay income tax at their own marginal rate if they withdraw money. In both cases, the pension can be passed on for anyone’s benefit, including a surviving spouse, children or grandchildren.
Because pensions can be passed on free of Inheritance Tax, they are a more efficient way of passing on wealth to future generations. All other assets that a person passes on after death will be subject to Inheritance Tax at the rate of 40%. This would include any savings, investments and ISAs. If the pension is preserved and the other assets are used to live on, the pension can be passed onto subsequent generations, whether as a cash lump sum or a pension, without any tax charge.
Your Will is a critical part of succession planning and should be the starting point for any conversation about what happens after your death. However, it is just as important to think about what happens to your pension once you die. Because your pension does not form part of your personal estate, it will be dealt with by the trustees of your pension fund. This means that it is important to make sure that your nomination letters are up to date and properly reflect your wishes.
Deciding whether to transfer a cash lump sum or the pension itself needs detailed consideration and good professional advice. This issue needs to be considered as part of the overall estate plan, particularly where you have a spouse or children, and will be affected by a number of factors.
For example, when faced with the option of receiving a lump sum or the benefit of an ongoing pension, the tendency may be to opt for the lump sum. However, this may not be the best option as it may impact on the tax exposure further down the line. Transferring the pension to a beneficiary within the pension environment would have the advantage of giving them the access to the funds, but without it increasing the value of their estate.
All of these matters need to be balanced against the needs of the beneficiary and any restrictions on the pension itself.
For most people, pension freedom has caused a massive culture change and this will not come easy to many. However, with some careful planning and advice, you can help reduce the impact on Inheritance Tax on your estate so that your beneficiaries have more money to enjoy after you’re gone.
Tax and estate planning is more complex than it has ever been and obtaining proper professional advice as early as possible is critically important.
The terms of the specific pension scheme will need to be considered and we can work with your financial advisor to make sure that everything is set up according to your wishes and in the most tax-efficient way.