Pardon? Did you say don’t draw your pension?

5th December, 2017

Did you say don't draw down your pension Trees with question marks on themYou may have heard that in the year to May 2017 Inheritance Tax (IHT) receipts hit a record high of £5.1 billion, providing a useful 9% increase for The Treasury over 2016 figures. Although useful for The Treasury this statistic is somewhat depressing for families whose estates have to pay this tax, very often because of spectacular property price growth over the last 40 years.

What has this got to do with my pension pot you might ask? Well, in 2015 a series of changes were made to pension rules which introduced many new flexibilities one of which was a change in the way pension funds are treated in respect of taxation on death. Previously you were only able to pass on a pension fund to the next generation free of tax if you died before age 75, not a great strategy. Although the pre-75 distinction still provides the greatest tax benefit the post 75 death terms have seen some major improvements.

Previously passing on a fund after age 75 meant a tax charge on the amount paid out of 55%, a full 15% more than the IHT rate of 40%, this was why many people felt they had no option but to purchase an annuity at age 75 to try and preserve some value through a guarantee built into the annuity. This however was inflexible and annuity rates were dropping like a stone due to low interest rates and increased life expectancy.

Fast forward to 2015 and the picture has very much changed, you can now nominate a range of potential beneficiaries to your pension funds, spouse, children, grandchildren etc. If you die before 75 your beneficiaries can usually inherit your unused pension fund (not final salary pension) with no tax consequences providing your total pension are within the Lifetime Allowance. The recipient(s) can either take your pension as a one off lump sum or they can transfer it to a pension of their own and draw it down as and when required or if never required, they in turn can pass it on to their beneficiaries.

If you die after age 75 the same process can occur but the tax benefits are not quite as attractive. Any inherited pension that is drawn down by the beneficiary is taxed at the beneficiary’s marginal tax rate. With careful planning the fund could be drawn down over several years perhaps at basic rate tax of 20%; half the rate of IHT.

Having explained the tax and accessibility features the key question is whether you should even draw down anything from your pension during your lifetime. If you have an estate that exceeds the IHT threshold and have other assets such as ISA portfolios, dividends from shareholdings or investment properties which meet your income needs it may be that you could leave your pension fund intact, drawing instead from other assets that are subject to IHT.

There are some other important technical considerations to consider in relation to the tax efficiency of your pension on death including how you have detailed the nomination of death benefits and revisiting any Trust arrangement that you may have put in place connected to your pension plan. These both need reviewing if they haven’t been looked at since the rules changed in 2015.

If you would like to minimise your IHT liability, joined up financial and tax planning is key to establishing the optimal outcome for your estate. A full review of your circumstances to determine how your needs can be met during your lifetime whilst also minimising the tax on your estate can result in significant tax savings.

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