Personal Pension  

Pensions improve as death benefits

Pensions improve as death benefits

Changes to pension legislation following last year’s Budget have given rise to various talking points. With increased flexibility and significant changes to the tax treatment of death benefits, one of the more popular points is how a pension can be passed on to family members including children and grandchildren.

Passing on a pension fund is nothing new of course. However, before the recent changes the obligation has always been that pension death benefits need to be distributed to a ‘financial dependent’ first and foremost (a financial dependent typically being a spouse/civil partner or a child under the age of 23). From 6 April this changes and anyone can be nominated to receive a pension death benefit.

Age UncrystallisedCrystallised

Lump sum or income on death can be passed on tax-free to any beneficiary (up to the deceased’s lifetime allowance)

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Lump sum or income pension can be passed on tax-free to any beneficiary
75+Any beneficiary can draw down on the fund at his marginal rate of tax or 45% charge if paid as a lump sum (changing to marginal rate from 2016/17)Any beneficiary can draw down on fund at his marginal rate of tax or 45% charge if paid as a lump sum (changing to marginal rate from 2016/17)

While no-one can predict his demise, these welcome changes now offer greater potential to pass on a pension fund with smaller tax deductions. It is now possible for someone’s pension to become a lasting family legacy as a result of it passing to a nominee, who in turn can appoint successors to inherit thereafter.

For estate planning purposes, there should be no inheritance tax payable by the person inheriting the pension pot. Similarly, there should no lifetime allowance to worry about either. That said, this needs to be caveated and it is worth revisiting the current rules and putting these in perspective with the changes due to take effect in April this year.

The existing rule that distribution of death benefits must be paid within two years still applies, but for those who have died in recent months it is perfectly legal to delay the distribution of death benefits until 6 April 2015 to take advantage of the forthcoming changes. For many estates, two years is considered ample time. However, if there are family disputes or it is unclear who the beneficiaries are, then two years is not long at all. If distribution of death benefits occurs after two years, then the flat rate of 45 per cent tax or the recipient’s marginal rate of tax applies (where previously this would have suffered an unauthorised payment charge of 70 per cent).

Spousal bypass trusts

Another potential issue is the use of a pension trust as a vehicle for parking death benefits. For many, spousal bypass trusts have helped avoid or mitigate a surviving spouse’s inheritance tax position. Now, their use is being called into question given the 45 per cent tax charge that will apply to death benefits paid into trust after age 75, which is when the individual is more likely to die.