New rules provide tonic for succession planning

While you may not be able to escape the former, the latter can be avoided or at least reduced.

Although the pension freedoms giving unfettered access to whole pension pots grabbed the main headlines when introduced in April, it is the changes to the tax treatment on funds remaining in pensions on death that provide the greatest tool for avoidance of tax and efficient succession planning.

The new rules remove two of the key distinctions on treatment of death benefits, which often caused clients dilemmas – namely different treatment for vested and non-vested pots and for benefit payments to dependents and non-dependents.

The only factor now impacting on the differing regimes and taxation of death benefits is the old enigma of reaching age 75.

With this new regime, the key to effective planning is knowing to whom benefits can most efficiently be paid. This is a decision made by the pension scheme administrator, based on the last nomination or expression of wish information left by the deceased member.

However, this is no longer a one-hit event, as remaining benefits left undrawn on the death of the first beneficiary can cascade down to other successive beneficiaries – known as successors – nominated by the first named beneficiary following the original member’s death.

For this reason regular evaluation of death benefit nominations – not only of the member but for subsequent beneficiaries – is crucial.

Returning now to death pre age 75, the benefit payments can be paid out free of either inheritance or income tax, irrespective of whether or not retirement benefits have come into payment, whether the beneficiaries are dependent or not, and irrespective of whether the payments are by lump sum or through a series of drawdown payments.

To ensure the payments retain this tax-advantaged status, it is necessary for lump sums to be paid within two years of the member’s death, or a designation of funds into drawdown for the recipient must be made where drawdown is to be the method of payment.

On first impression, the ability to withdraw funds tax-free immediately would be the route to follow.

But it must be remembered that the funds can be withdrawn tax-free under drawdown at any time, and thus maximising them in the tax-exempt environment and drawing them only when needed might be a more tax-efficient plan.

Care must be taken, though, as the tax treatment of benefits paid from funds remaining on the death of the first beneficiary is dependent upon the age at death of that beneficiary and not of the original member.

Turning now to benefits paid on death post age 75. These can also be paid either in lump sum or drawdown of income format and will usually suffer marginal rate income tax in the hands of the recipient. The anomaly being that lump sums paid in the current tax year will be subject to a 45 per cent tax rate.

Key to planning here is the member can also nominate both dependents and non-dependents and a strategy can be created where a series of income payments can be made, keeping beneficiaries below their next band of higher-rate tax.

An effective strategy of dealing with death benefits could impact the member’s decision to draw retirement benefits at all, or if so at what level.

It may be more tax efficient to live from drawing down personal assets, thus reducing an estate that may be subject to inheritance tax while leaving the pension fund intact.

Martin Tilley is director of technical services at Dentons Pension Management