Many of us want to leave an inheritance to our family or friends. Fortunately, it’s become easier to do thanks to new rules which let you pass on your pension wealth more freely and tax efficiently.
And that means pensions have a surprisingly important role in inheritance planning, as long as you take the right steps. Here’s how…
What’s changed – and how it could affect you
Last year’s big pension shake up means you can now take your pension savings when and how you want from the age of 55.
What’s less well known is how tax efficient – and easy – they can be in passing wealth down the generations.
Greater flexibility over who can inherit your pension means you can leave it to your adult children, who may have long since flown the nest, and not just your financial dependants.
Even better, the rate of tax they might pay has fallen too.
But this means the type of pension arrangements you have, and how and when you take your pension, have become much more significant…
Pensions can be inherited tax free
If you have a pension which allows you to take your money as and when you want (called income drawdown), it can sometimes be passed on entirely free of tax.
Your beneficiaries could inherit your unused pension fund tax-free if you die before the age of 75. Over the age of 75, your pension provider will deduct income tax from anything they take.
Your beneficiaries could receive either a lump sum on your death or they can inherit your drawdown plan as their own pension pot.
‘Inherited drawdown’ allows your beneficiaries to take out as much or as little as they need, when they need it, without having to wait until they retire.
A guide to death benefits from your pension, provide for your loved ones.
What you’ve already taken from your pension, and haven’t already spent, is part of your estate
If you have taken all or some of your savings out of your pension – to put into a bank account or another type of investment for example – they become part of your estate and could be subject to inheritance tax. This includes anything left unspent from your pension tax-free lump sum.
Money held inside your pension isn’t generally included within your estate and is typically free of inheritance tax.
So unlike your other assets, who gets your pension isn’t normally covered by your Will.
Instead your pension provider will usually decide who gets what from your pension when you die. Your pension is probably one of your biggest assets along with the family home. So how do you know your pension provider will pay out to the people you want to benefit?
You need to let your provider know how you would like the pension benefits to be paid, and who they should pay them to, by completing a nomination form. You get this from your provider.
Again, keeping it up to date is vital, particularly when circumstances change: think marriage, birth, divorce or how the taxation of death benefits changes at age 75.
Or you’ve simply changed your mind about who you’d want to benefit.
If you don’t nominate them, your children may not be able to receive your pension as ‘inherited drawdown’. The only option may be to pay them a lump sum which, if you die after 75, could see a large slice of their inheritance taxed at 40 per cent or even 45 per cent.
Be aware, not all pensions are fully flexible
Not all types of pension can be passed on in such a tax-efficient way.
Some older-style pensions may not be able to offer all the new death benefit options available and if this flexibility is important to you, it could mean you want to consider transferring to one that does.
It could be a good opportunity to combine all your pensions into one which makes managing things easier. But do check whether any older-style contracts have valuable guarantees which might be lost on transfer. There are other considerations and this may not be the right option for everyone.
Why it makes sense to plan ahead
It’s all too easy to think it’s something that can be put off until you’re either close to retirement or have finished working. But unexpected things can, and do, happen.
You need to be in the right kind of pension before ill-health becomes an issue if you want your beneficiaries to be able to take a flexible income from your remaining pension pot. Transferring your pension while in serious ill-health could lead to inheritance tax being charged when you die. And this could mean less money in the hands of those you wish to benefit.
Are you prepared? If not, then act now
Considering all of this, it’s easy to see how pensions have become so important as a way of passing on your wealth.
Just make sure you’re prepared, your pension choice is appropriate and that all-important paperwork is up to date.
MAS (the Money Advice Service) has comprehensive guidance on sorting out an estate when someone dies, including information on tax, probate and debts.
Access to impartial guidance
We recommend you seek appropriate guidance or advice before you make any decisions. An adviser may charge a fee for this. You can also get free impartial guidance over the phone or face to face with Pensionwise. Go to pensionwise.gov.uk or call 0800 138 3944. Make sure you understand all your retirement options by reading the Money Advice Service guide – Your pension - it’s time to choose
Keep up-to date with the latest retirement news and expert opinion.