Let’s talk about pensions. Most of us, once we reach a certain age, establish a plan of some kind or other and begin monthly payments. All very sensible, but in our understandable preoccupation with the ultimate value of our pension pots, it is easy to overlook certain issues. Have you ever considered, for example, what will happen to your pension savings when you die?
There is a widespread misconception that any remaining funds would pass under the terms of our wills or that payment would automatically be made to our spouse. In fact, ‘death benefits’ as they are termed, usually pass to family members at the complete discretion of the trustees of our particular pension scheme – i.e. strangers we are unlikely ever to have met. It is therefore vital to ensure that these trustees our aware of our wishes. This process should include updating our will so that it deals with our other assets in a tax efficient way.
Pension death benefits are usually not liable for inheritance tax (IHT) and so have always been considered a valuable tool for passing funds to loved ones. But until very recently, beneficiaries were subject to a number of other penalties. The exact penalty usually depended on the type of payment, the type of pension pot and the age of the pension pot’s owner when they died.
But things have changed.
Sweeping changes to defined contribution pensions, including personal pensions, workplace personal pensions and self-invested personal pensions were introduced this month. Not only is it now easier for an individual to access their pension pot during their lifetime, but there is also a less onerous tax regime on the beneficiaries inheriting the pension after that person dies This may make pension savings a much more attractive tax planning tool in the future.
Your age at death will still, however, determine how your pension death benefit is treated. We would recommend that anyone affected by the changes seek detailed independent financial advice on the precise implications for them. But, broadly speaking, if an individual dies before the age of 75 the beneficiaries of the pot are no longer saddled with a tax penalty taken from the fund by the pension provider. If an individual dies after age 75 the old rate of penalty is reduced from 55 per cent to 45 per cent. There is also greater flexibility in the ways beneficiaries can receive the funds, and this can also affect the tax payable.
The new legislation should be carefully navigated. Not only do individuals need independent financial advice but they should also seek specialist legal advice to put in place a carefully crafted will. This process should include consideration of the pension death benefits that would be payable in different circumstances and it should, as mentioned, also ensure that the pension trustees are notified of the person’s financial wishes. This should dovetail neatly with any lifetime planning.
Many people find pension planning a difficult and even daunting topic. Informed advice is vital and can make all the difference. There is no doubt, however, that these wide-reaching pension reforms present some exciting opportunities and it will be interesting to see how they play out in the future.