Passing on your pension assets

What you’ll learn:

• The difference between ‘defined benefit’ and ‘defined contribution’ pensions.
• Nominated beneficiaries and the ‘after age 75’ tax rules.
• The importance of the ‘lifetime allowance’.

When the Government introduced the ‘Pension Freedoms’ in April 2015, the tax rules were changed for payments made to beneficiaries when the pension pot owner dies. For certain types of pension, money left behind on death can be passed on to anyone you choose. However, some important factors determine whether your pension is taxable on your death. These include the type of pension you have, your age at death, and the combined value of all your pension pots.

What type of pension?

There are two main types of pension – the Defined Contribution (DC) or ‘Money Purchase’ pension and the Defined Benefit (DB) or ‘Final Salary’ pension.

DC pension pots allow you to pass on your pension pot to others, making them very useful for inheritance tax (IHT) planning.

DB pensions, and annuities purchased from DC pension pots, give you an income in retirement and usually provide a reduced income to your spouse or beneficiary when you die and this normally stops when your spouse or beneficiary dies. The IHT flexibility mentioned above is not available to DB pensions and therefore your age at death isn’t relevant.

Further details on DB and DC pensions can be found in our article here.

Choosing beneficiaries

Pension savings are not covered by your Will. Therefore, you have to make a separate decision about who you want to inherit your pensions. This means that you will need to let your pension scheme know who you would like to receive your pension when you die (this is usually done on an ‘Expression of Wishes’ form and the people you choose are known as your ‘nominated beneficiaries’). Trustees don’t have to follow your wishes but at least they will know what they are when deciding on the beneficiaries. If you don’t let your pension scheme know who should inherit your pension, the trustees will have to decide on your behalf and it could end up in your estate. Your beneficiaries will be able to choose whether they receive your pension savings as a lump sum or as a regular income. If they don’t spend it all, they can also choose who should receive the pension they have inherited from you when they die. This allows pension savings to flow tax-efficiently down to later generations. It is possible to pass your pension to a charity organisation if there is no specific person you would like to leave it to. It makes sense to revisit your beneficiary nominations regularly to ensure they are still appropriate and make changes if necessary.

Older or younger than 75?

With a DC pension, if you die before age 75 and have started to withdraw money after April 2015¹, your nominated beneficiary can inherit your entire pension pot and make withdrawals without incurring any tax deduction. The payment to a beneficiary’s pension must be made within two years of the date the pension scheme is notified of your death.

Otherwise (i.e. if you die on or after age 75, or the payment to the beneficiary’s pension²happens after two years), your nominated beneficiary can inherit your pension pot without any IHT tax deduction. However, when they withdraw any of that pot they must pay income tax at their marginal rate.

The value of your pension pot

The government controls the amount of tax relief available for pension schemes by limiting the total value of all your pension savings. The total value limit is called the ‘Lifetime Allowance’ (LA), and is currently £1,055,000 (as at April 2019). Above this limit, an additional tax charge may be payable when pension money is inherited.

Conclusion

Pensions are not only a tax-efficient vehicle for saving money for the future but can also be a very tax-efficient way of passing on your wealth to future generations. This is a complex area and you may wish to seek professional advice to ensure you are maximising the tax-efficiencies on offer.

These are our current opinions but the future, as ever, is uncertain and outcomes may differ. Bear in mind always that future tax rules may change and their effects on you and any beneficiaries will depend on individual circumstances. We don’t offer personal tax advice. If you’re unsure seek independent advice.