Ripping up the retirement planning handbook – Part 3

In the final part of our three part series of blogs on  retirement planning, we consider the change to pension funds becoming inheritable assets.

Keeping pensions in the family

First announced at the start of the Conservative Party’s September 2014 annual conference, the ability for unused pension funds to be passed on to future generations became effective from 6 April 2015. This has made pension funds potentially the inheritance tax planning ‘tool of choice’ and is one of the most exciting developments for pensions in decades!

Under the new rules, pension funds that are unused on death can be left to children, grandchildren or anyone else you care to nominate as a beneficiary. They do so as ‘super tax efficient’ vehicles. Pension funds are outside of your estate for inheritance tax purposes and, in addition to that, they will be outside of the beneficiaries’ estates and also will not count towards their own pensions lifetime allowance. And, on top of that, they remain as pension funds, so assets within the pension funds grow tax free while the beneficiaries don’t have to be a minimum of 55 years of age to access the funds, unlike with normal pensions.

The beneficiaries may or may not then be taxed on withdrawals. This is determined by the age at which you die. If you die before you’re 75, your beneficiaries can draw an income or lump sum tax free. If you die after 75, your beneficiaries are taxed on the income and lump sums at their marginal rates (except for lump sums in the current tax year, 2015/16, which are taxed at a flat rate of 45%).

What’s the big deal, then? Well, potentially this turns financial planning on its head! If your pension fund is ‘super tax efficient’ for you and the next generation, financial planning for the retirement years of wealthy individuals should be about spending personal wealth and preserving your pension funds, passing them on when you die. In doing so, everything you spend – be that capital used as an income replacement for your pension, normal capital spends on holidays, and helping your children and grandchildren – has 40% tax relief in terms of the inheritance tax you might otherwise incur on your personal estate above the nil rate bands. Try to bear that in mind the next time you quiver at the cost of flying business or first class! There are two knock-on issues which you will need to think about:

• First, what’s the right level of spending from your personal wealth to see you through your days without running out of money (although you will always have your pension fund to fall back on), and how will you achieve this?
• Second, if you can preserve a pension fund to be passed on, what should the underlying investment strategy look like and does it need to be revised, now that you have a new objective?

These changes also create a new driver for those with valuable defined benefit pensions which offer the promise of a pension for life but one that dies with you. Coupled with current relatively high cash transfer values for defined benefit pensions (a by-product of historically low yields on government bonds), the option of taking a cash transfer value and reinvesting in a self-invested personal pension (SIPP) which could then be passed on to children or grandchildren is worthy of serious consideration in the right circumstances.

To ensure that your pension funds are passed on as you would intend, you will need to keep your death benefit nominations up to date. Under the old pensions legislation, it made sense for many people to nominate their pension funds to be paid to a discretionary trust in order to avoid a potential inheritance tax charge on the death of their spouse. Under the new rules, the payment of death benefits to a discretionary trust will be taxed at a flat rate of 45% and, once the funds are within the discretionary trust, they will be taxed at the usual trust rates. This compares with a pension fund passing tax free to the beneficiary, and them determining whether tax is to be paid and at what rate.

You shouldn’t, however, completely discount existing nominations to a discretionary trust, and in some circumstances they may still be relevant where control ‘beyond the grave’ is important. So, reviewing death benefits will be a key planning point to revisit. And, to dispel a common misconception, the destination of your pension funds is not governed by your Will. In the absence of any nomination, it could be the pension scheme administrator who has the final say as to who gets your pension funds!

Many people may initially be quite cautious about this latest change in their ability to pass on pension funds to their children. However, taking a long-term view, the biggest risk may be a future change to pensions tax legislation – although, if this does happen, as is the case with all tax planning and subsequent tax changes, any impact should be manageable in one way or another. So, the possibility of passing on pensions will have ripped up old retirement strategies while creating exciting new options for some.

If you’d like to discuss the impact of any of this on your pension and retirement planning, please get in touch with your usual Cooper Parry Wealth contact on 01332 411163, or email Jonathan Elsigood.