by Ian Campbell
Director & Chartered Financial Planner
Death and taxes – not the most pleasant of subjects, but bear with me! From the financial perspective it is crucially important that the i’s are dotted and the t’s crossed – the last thing a family needs is more stress following the loss of a loved one.
It is common for people to think that once the will is in place then that’s it, their assets will go to their chosen beneficiaries; but, that would potentially be missing one of the largest sources of wealth an individual can own – their pension.
Before I go any further, if you don’t have a will, this should very much be a priority. The rules regarding intestacy in Scotland are complex, divided into ‘prior rights’, ‘legal rights’ and the free estate. Not something you want to take a chance on, so please consult a solicitor.
Going back to pensions – “what’s the point, as when I die the insurance company will just keep it all?”
This above is one of the most common misconceptions regarding pensions in the UK. Which, given the frequent changes to legislation and the rather, let’s say “non-complimentary” press-coverage, is perhaps somewhat understandable.
However, after a few simple checks, it is fairly straightforward to prevent any remaining pension fund disappearing into the insurance company void.
For some context, let’s fly back to 2015 – doesn’t seem like four years ago does it? Back to the days when the B word wasn’t a constant background bombinate.
2015 saw some big changes to pension legislation, more commonly known as the ‘Pension Freedoms’. One of the most interesting changes was the increased ability of an individual to tax-efficiently pass their pension fund to anyone of their choosing.
The rules now allow an individual to nominate a ‘successor’ who can inherit the balance of their money-purchase pension scheme, also known as the death benefits. This successor does not have to be financially dependent on the pension member.
The key number regarding pension death benefits is age 75. If an individual dies prior to the age of 75, the pension funds pass to the successor and can be withdrawn free of income tax. If a person dies over the age of 75, any withdrawn funds are taxed at the marginal rate of the recipient. The good news is that regardless of the age of death, the pension will pass to the next generation free of inheritance tax.
Or will it?
One of the more subtle things to consider regarding the 2015 changes, was that while the updated rules are in place for new pensions, they were not imposed on existing policies. In other words, that old pension you have from years ago, quietly growing year after year, may not be able to be passed on in the most efficient way.
For example, some older pension schemes allow only a ‘Return of Fund’ option on death. Now, that sounds like the right outcome, but it is actually the exact opposite. Most often, return of fund will see the pension paid back into the estate of the deceased. What this means, is that the funds may then be exposed to Inheritance Tax (IHT), at the hefty rate of 40%. Not the best outcome, really.
Much more preferable is to use the option of dependant, nominee or successor drawdown. This allows the assets to remain in a pension environment, pass free of IHT, and then either be withdrawn as required or stay in the very tax-efficient environment of a pension.
So, while our minds naturally head to the drafting of a will when considering who will inherit our assets, we should also give some thought to our pension savings. It is not unusual for people to have made a nomination when the pension was first established, which no longer reflects their wishes.
Reviews and good planning can ensure we make full use of the very generous pension options, particularly when we want to help out the younger generation.