It’s now five years since the pension industry was shaken up with the introduction of Pension Freedom legislation. Many of the early headlines focused on the likelihood of pensions being cashed in to purchase luxury items, remember the headline "if people do get a Lamborghini, and end up on the state pension, the state is much less concerned about that, and that is their choice."
Pensions can be very complex and therefore it’s perhaps understandable that at the time the press focused on such sensationalist headline grabbing quotes as this.
One element not widely discussed is the impact that Pension Freedoms had on the death benefits associated with defined contribution, also known as money purchase, pension schemes. Prior to the Freedoms, pension holdings could only typically be passed on to:
A key change removed the requirement for the beneficiary to be a dependent allowing for benefits to be passed on to whomever the pension holder wished. Crucially, such funds fall outside of the deceased’s estate for Inheritance Tax purposes.
Therefore it is vital that individuals regularly review their pension fund nomination of beneficiary forms. It is not uncommon for such forms never to have been completed, or indeed to have been completed prior to a significant change in the individual’s circumstances, for instance the beneficiary being an ex-spouse/partner through divorce.
The tax treatment of pension death benefits also differs dependent on whether the individual passes away pre or post age 75.
Consider for example Mrs Jones, who passes away at age 74 leaving her pension savings to her surviving spouse, also aged 74. Mr Jones lives to age 76 before also passing away, at which point the inherited pension savings are divided equally between their children. Mr Jones never withdrew a penny from the inherited funds, as he had sufficient income to maintain his lifestyle without these funds.
As Mr Jones had passed the milestone age of 75 before dying, the funds, when paid out to the children, will be taxed as income at their tax rate. If the pension funds are of a reasonable size this could push the recipient into the higher or indeed additional rate tax band and mean that a significant percentage of the inherited funds are therefore lost to taxation.
Let’s go back to when the couple were both still alive, and both aged 74. Through working with a financial adviser it may have been possible, depending on their circumstances, to determine that upon the death of the Mrs Jones, her surviving spouse would not have required the funds. In this case, the nomination of beneficiary forms could have been amended to ensure the funds passed directly to their children. As this occurred, whilst Mrs Jones was under the age of 75, the children could access the funds how they want, when they want and without losing unnecessary money to tax on her pension.
As you can see the role of nomination of beneficiaries in financial planning can be crucial. I advocate reviewing this regularly to ensure that funds are passed on to whom you intend, and this is done in as tax efficient manner as possible.
At Armstrong Watson our quest is to help our clients achieve prosperity, a secure future and peace of mind. We can provide a full review of your pension arrangements and discuss the opportunities available to you with our compliments in the first instance. You can also now do this remotely by video, telephone as well as face to face.