It is apparent that the current Coronavirus pandemic has focused the minds of many when it comes to resolving their financial affairs. When the very real prospect of dying stares you in the face, the need to get one’s house in order comes to the fore, actioning today that which is often readily put off until tomorrow. One such aspect that is being addressed relates to pensions and death benefits.
We have covered the subject before some years ago, when the subject was still relatively new, in the article Pension Death Benefits Revisited. However, it is worthwhile not only reemphasising this but expanding further.
In summary, in the event of your death before your 75th birthday there are three options:-
- Nominated beneficiaries could use the remaining fund and buy an annuity, tax free;
- They could continue with drawdown and draw income directly from it, tax free;
- The fund could be paid to them as a lump sum, again tax free.
In the event of your death from age 75 there are three options:-
- Beneficiaries could use the remaining fund to buy an annuity, taxed at their marginal rate;
- They could continue with drawdown and draw income from it, taxed at their marginal rate;
- The fund could be paid as a lump sum to them, taxed at their marginal rate.
It is important to establish that a beneficiary can now be anyone, not just a widow, widower, surviving civil partner, or dependant which was allowed under the old rules.
These are the rules and regulations and what can be permitted. However, what can be facilitated by your own plan may well be a different matter altogether.
Since 2015, when the pension freedom rules came into being and when the changes to death benefits came into effect, it is fair to say that many pension providers chose not to invest in upgrading their technology infrastructure upon which older legacy pension arrangements are held and administered. Some providers have avoided this problem by offering to transfer into newer, more flexible products which can facilitate the full range of options. Some, however, have not and this is not restricted to those pension providers that are closed to new business.
Indeed, we came across such situations recently with two prominent, well known insurers in the pensions market.
The first sought to automatically convert the whole pension fund into an annuity at age 75, effectively removing lump sum death benefits and precluding ‘other’ beneficiaries, as any pension beyond that for the pension holder could only be payable to those dictated within the old rules.
The second sought to force the client to take their tax free cash (TFC) payment before age 75, otherwise unbelievably this would be remitted to HMRC, whilst converting the remainder to an annuity.
These approaches are not enforced within the pension freedom rules but rather are within the terms & conditions of the individual policies.
I am sure these two pension providers are not alone in these quirky, rigid and wholly unfair rules. And clearly it is likely to apply to specific older plans rather than more modern policies. However, as we have seen from many of the clients we have dealt with, plenty do have old plans which have not been reviewed in some considerable time.
It is important to remember that funds held within a pension are outside of the estate when it comes to assessing Inheritance Tax (IHT). As such, other assets and investments being utilised to fund one’s retirement is a tax efficient approach in this regard. However, given the differing tax treatment, age 75 is clearly an important date in the diary when it comes to planning around any pension fund.
Where one has not done so already, as in the cases studies above, should you draw your tax free lump sum? Certainly if it is going to be paid to HMRC! This is a decision both pre & post 75 and will depend upon your current IHT position. Drawing it whilst alive will clearly have no Income Tax repercussions but if drawing it out takes your assessable estate over the nil rate band, it could be subject to IHT at 40%. If you should die pre 75, this would continue to be paid tax free to your beneficiaries. Leaving it in post 75 means that upon death it would be assessable at the recipient’s marginal rate. This might depend on how and when the beneficiary draws upon it but this could be more advantageous than an immediate 40% IHT bill.
With regard to funds over and above TFC, these would be subject to Income Tax at the recipient’s marginal rate during their lifetime and the decision to draw them could be influenced by whether they would be spent. Use of one’s annual personal allowance of £12,500 (2020 / 2021) could result in this being drawn tax free with excess funds likely subject to 20% Income Tax. Pre 75 these would be tax free to the beneficiaries and post 75 subject to their marginal rate. This compares to 0% IHT or 40% IHT.
Of course these are not considerations if the fund is automatically converted to an annuity, as noted previously.
One case we come across very recently is that of a client who was the recipient of a pension fund upon death. The client in question unfortunately lost his wife a few years ago and, having died pre 75, received her fund within successor / nominee drawdown and so he can draw upon it all tax free. He is 73 and now approaching the time when the tax treatment of what is now his fund may change. Drawing it out now does not have any Income Tax issues for him and should he die before 75 neither will his 2 children. Due to the size of his estate, withdrawing the pension fund does not create any IHT issues and so again his children will likely receive the funds without deduction of tax at all. However, should he not draw upon it, and as is hoped live many a year beyond 75, whilst the fund remaining in the pension wrapper will be outside of the estate for IHT, it will become subject to the children’s marginal rate of Income Tax. As both children are currently higher rate Income Tax payers, to avoid it and perhaps to reduce it to basic rate at best, they are likely to need to defer drawing on it until their own retirement.
In conclusion, we consider reviewing your pension to be essential, not only to ensure you plan your pension in life and in death as effectively as possible but importantly to ensure that your current provision provides the full range of options which are permitted within the current rules and regulations.
Feel free to contact us for an informal chat or to arrange a formal pension planning review.