With pension freedoms that came in in April 2015, the tax implication on pensions on death were amended as was the way in which pensions could be inherited. The changes meant that if you die before age 75 the pension fund can be passed to your nominated beneficiary free from any inheritance tax or any other tax. If you died after age 75, the pension could be passed to your chosen beneficiary free from inheritance tax. Any withdrawals would be taxed at the recipients’ marginal rate (their income tax rate).
The pension could remain invested and be used to provide an income and/or lump sums now or in the future. The pension could be passed to spouse, children, grandchildren and they could do with it as they pleased. This is what is called a dependents or nominee pension/account.
Although some older style pensions have updated their contracts to offer flexi-access drawdown following the pensions freedoms, many have not updated their plans to allow for a dependents pension and will pay out a lump sum on death.
This may sound all well and good in theory however, let’s take a look at this in practice.
Bob has £100,000 invested in pensions. His chosen beneficiary is his wife Audrey. Bob sadly passes away when he is 62. He has life cover as well as other investments. His pension contracts have not been updated and do not have the option of a dependents pension. Audrey therefore receives the death benefits as a return of the fund value from each provider. Audrey doesn’t need the capital from the pensions and therefore looks to reinvest £100,000. She is restricted in the amount that she can pay into pensions and ISAs. Therefore she has to structure her investments to invest tax efficiently over a number of years.
Had the providers offered a dependent’s pension, the money would have remained invested tax efficiently and Audrey could have accessed the money tax free as and when she required.
Now, had Bob died when he was over age 75 and the fund value was still £100,000, when the providers had returned the fund to Audrey, she would have been taxed at her marginal rate. Even if Audrey had no taxable income (which is unlikely) some of the funds would be subject to tax at 40% on a proportion of the fund:
- £11,500 @ 0%
- £33,500 @ 20% £6,700
- £55,000 @ 40% – £22,000
- £28,700 tax would be payable.
If the monies had been paid into a dependent’s pension, Audrey could have taken income and/or lump sums the she required and she would be able to do so within the personal allowance or basic rate tax threshold each year. Thus saving between £11,000 and £28,700 in tax.
Where pensions do not have a nominated beneficiary, providers will often pay out a lump sum to the estate. It is therefore important that you ensure that your pensions as well as your nominated beneficiaries are up-to-date.
If you would like to review your pensions, contact me for a no obligation complimentary initial meeting.