Over the last few years the rules if you inherit a pension have changed significantly. Unlike other areas of pension planning such as the pension annual allowance and lifetime allowance the changes to pension death benefits are certainly for the better.
Different ways to inherit a pension
If you are a member of a defined benefit pension scheme (final salary) then you will have little choice in how you leave your pension benefits should you die. If you have already started receiving your pension income then usually only your spouse will be able to continue receiving some form of income which is likely to be reduced.
It’s the same if you are already receiving a pension annuity and will depend more on whether you opted for a pension annuity with a spousal benefit or not.
But when it comes to defined contribution pensions (money purchase) there is a lot more choice. In summary:
- You can nominate who benefits from your lump sum pension pot.
- Your beneficiaries can receive a lump sum payout or leave the money in a pension and draw money out as and when they want to.
In terms of taxes:
- Your pensions are not included in the Inheritance Tax calculation (therefore IHT free) on your estate providing you did not die 2 years after making a pension transfer and knew you were in ill health.
- If you die before 75 then your beneficiaries can withdraw the entire lump sum or make smaller withdrawals from your pension Income Tax free.
- If you die after 75 then your beneficiaries will need to pay Income Tax at their marginal rate on any withdrawals they make.
How to reduce or avoid tax for your beneficiaries who inherit a pension
Whilst the changes to the rules when you inherit a pension now offer greater opportunity for planning there are things you need to check and consider to ensure you can make the most of them.
#1 – Check your pension death benefit form.
- Often called an ‘Expression of Wish’ form.
- This is where you nominate who gets to inherit a pension.
- If you don’t have one then get one sorted as otherwise the pension provider/trustee may decide who has it.
#2 – Check the death benefit options available with your current pension provider
- Whilst these new rules are great, older style pensions may not have the ability to allow flexible withdrawals for your beneficiaries.
- This could mean that your beneficiaries have to take your pension death benefits as a lump sum paid into their estate which will increase their own Inheritance Tax position.
- Therefore making something IHT free now liable to IHT!
#3 – Think about your beneficiaries carefully
- For couples it’s usual that you nominate each other to receive death benefits in the first instance but consider whether your partner really needs the money.
- If you die aged over 75 then your partner may pay higher rates of Income Tax than say your children or grandchildren.
- If your pension is an older style pension that doesn’t allow your partner to keep the money in a pension then they will be receiving a large lump sum that not only suffers Income Tax (if you die over 75) but also brings the money back into the estate liable to Inheritance Tax!
If you would like help understanding your pension death benefits and how you can make the most of the new rules from a planning perspective then please give us a call. We would be happy to have a brief look at your pension in our initial consultation at our expense and will point you in the right direction.
Risk warning:
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.
