With pension flexibility came changes in taxation of death benefits. Most pensions are written in trust so that the value of the pension does not fall within the deceased’s estate for inheritance tax purposes.
But what about the individual or individuals who inherit the pension – what is their tax position? It depends on how old the deceased was when he or she died as the following information illustrates:-
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Age at Date of Death |
Options & Taxation at Date of Death |
|
Pre age 75 |
Tax free lump sum |
|
Tax free income via drawdown |
|
|
Tax free annuity |
|
|
Age 75 or over |
Lump sum taxed at beneficiary’s marginal rate |
|
Drawdown tax at beneficiary’s marginal rate |
|
|
Annuity taxed at beneficiary’s marginal rate |
Any individual will be able to be nominated as a beneficiary.
The new rules also allow the nominated beneficiary to pass on any unused drawdown funds on their death to their own nominated beneficiary, known as a successor. The same tax treatment will apply but the relevant age will be the age of death of the beneficiary rather than the original member. If the original beneficiary dies before age 75 the successor can receive a tax free lump sum or continue with tax free drawdown. If the beneficiary dies age 75 or over then any benefits can either be taken by the successor as taxable drawdown income or a lump sum taxed at 45%.
This gives the potential to pass pension funds down through the generations without ever falling into anyone’s estate for inheritance tax (IHT) purposes. In addition, the funds can remain in a tax advantaged environment and have the potential to provide a tax free income where the member or beneficiary dies before reaching age 75.
Technically there is no end to this planning; a successor could also pass their remaining funds down to a further successor and so on. Of course, most members or their beneficiaries will need the funds to provide an income in their lifetime but this does give clients who have other funds a very useful planning option.