Intergenerational pension planning

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MON, 01 DEC 2014

Prior to the Finance Act 2004 (FA04), there was some excitement about the possibility of individuals passing pensions down through family generations. However, the FA04 and subsequent legislation put paid to this as a mechanism for estate planning, in that tax charges are imposed should pension rights pass to a connected party, e.g. spouse, son or daughter, other than where there is a pension sharing order, or death benefits are being provided.

The Taxation of Pensions Bill, which is currently working its way through Parliament, potentially drives a coach and horses through that element of the previous legislation. For the many people that have a personal pension, from 6 April 2015 the proposal is that on their death it will be possible for their beneficiaries to retain the fund within a pension. Currently, if non-dependants wished to access the fund, it would have to be paid out as a lump sum subject to a tax charge of 55% if the pension fund was in payment, or the member was over 75 at the time of their death. If neither of these were the case, then a lump sum up to the member’s remaining lifetime allowance could be paid tax free, with any excess taxable at the 55% rate.

The proposals also allow for the payment of a tax free lump sum to beneficiaries whether benefits have been taken from the fund or not, as long as the holder of the pension fund was under 75 at the time of their death. However, the payment of the lump sum takes the funds out of a tax advantageous environment and will form part of the estate of the recipient, which may have inheritance tax implications. Therefore, the idea of retaining the fund in a pension has a certain appeal. For example: Mr Smith was aged 77 when he died on 1 November 2014, and he was survived by his son Michael and daughter Jill, both of whom were in their late fifties. In addition to his other assets he left his £800,000 self invested personal pension (SIPP) – this did not form part of Mr Smith’s estate – to be split equally between them. As beneficiaries they requested the provider delay paying the death benefits until after 5 April 2015 to benefit from the new rules. Both elected to take a beneficiary’s flexi-access drawdown (FAD), with Michael drawing income from his fund subject to tax at his marginal rate of tax. Jill, on the other hand, decided to take no income, but unfortunately she died in January 2016; being survived by her two adult children Rebecca and Claire. As Jill was under age 75 when she died, her two daughters could take a lump sum death benefit free of tax from the fund, now worth £420,000. Claire decided to take £210,000, to use as a deposit for her first house, whereas, Rebecca elected for FAD, and used the tax free income to fund her children’s school fees. For clarity, if either Michael or Jill had taken the lump sum immediately after 5 April 2015, instead of the drawdown option, the payment would have been subject to tax at 45%.

This simple example helps to show why pensions will play an every increasing part in estate planning in the future. A word of warning: if your clients have a sizable pension fund, tell them to be very wary in future when their kids ask them what age they are!

An abridged version of this blog first appeared in What Investment