Retirement Symposium Q&As
Over the last two weeks we’ve held a crash courses on pension flexibility. We filmed the events and will be posting the video here and on our website shortly, so even if you didn’t manage to make it along to the sessions then you haven’t missed out. But for now, we thought it might be helpful to see some of the questions your peers put to our technical experts at the events, as you may be looking for answers to these, too. The technical guys answered the questions on the day and have added to those here for a fuller explanation.
Q: What are the tax implications of the by-pass trust? Why would you be worse off not using it?
A: If you die before you’re 75 the pension funds go into trust tax free but then you have taken the fund out of a low tax environment and put them into a high tax environment. Now there are ways round avoiding the high trust tax rates such as lending the money straight back out of the trust. If you’re over 75 and you took the lump sum it would be taxed at 45% which is the same rate as the rate applicable to trusts, so in this case there’s no difference. What will happen in 2016/17 when lump sums will be taxed at the beneficiaries marginal rate then it won’t necessarily be the most tax effective way to take the money out compared paying it out to an individual. In addition the key thing is that you’re in a very high taxed environment once the money goes into trust compared to the low taxed environment in the pension fund.
Where control over where the pension fund is eventually paid to is more important than tax planning then there will still be demand for a by-pass trust. For example where a member would like income to go to his second wife, but any remaining fund to go to the children of his first marriage on the death of his second wife then a by-pass trust can ensure this happens. On the other hand if the spouse took a flexi access pension she could access all the funds before her death.
Q: Take a client who is 75 in June who has an uncrystallised pension fund of £600k – from what you’ve said we can leave it in uncrystallised without any tax implications and at some time in the future the client can take tax free cash out of the fund. Have I understood correctly?
A: Presuming there is no LTA issue the idea of leaving it uncrystallised is that the pension could pass to people who are lower tax payers. He can still take his pension commencement lump sum tax free at any time, even after 75. If he dies aged over 75, then the fund is taxable and that would include the effective pension commencement lump sum element. But because he’s left it within the pension fund then it would be taxable in the hands of his beneficiaries at their marginal rate of tax, so if he picks beneficiaries with low/nil tax rates, such as great grandchildren then they can take the money out in a relatively tax efficient manner. If on the other hand he took out the PCLS and died a short time later, having left the lump sum untouched in the bank, then it may be liable to IHT at 40%..
The issue at the moment is that if he doesn’t take the PCLS and he dies then his whole fund is subject to tax at 55%, whereas going forward, the idea of using the pension as an estate planning tool becomes attractive, allowing non tax paying dependents/beneficiaries to take money out each year without paying tax on it.
Q: The new rules allow you to leave your pension to a number of beneficiaries, so say you had three children you left it to, would they each have their own pension pot? Or would there be one pot that all three would have access to?
A: It is likely to be treated as separate funds, which is James Hay Partnerships approach. Plus it wouldn’t count towards the beneficiaries lifetime allowance, it’s capital but it’s treated as income depending on the situation, if the person who left it to them is under 75. If the beneficiary has not reached the age of majority, then the parents or guardians control granddad’s inherited fund for the child. So even if granddad died aged 75, the parents could therefore decide to access the inherited fund up to their child’s personal allowance each year, with no tax liability. This could be used to pay school fees or to pay for the family holiday, so at long last you may be able to get the kids to pay for your holiday! …
Q: A client is coming up to 75 with a £200k fund and a £100k lifetime allowance, am I right in thinking that she could take out the £100k pre 75, roll the remaining £100k over then take it out without a life time allowance test? What about the BCE5A, how would the client avoid the lifetime allowance tax charge?
A: There are a number of BCEs at age 75, for instance a BCE 5a tests the growth on a crystallised fund, whereas a BCE 5B tests any uncrystallised funds. In this scenario the £100,000 uncrystallised pot would be covered by a BCE 5B, and as there is no longer the option to take this out as a lifetime allowance excess lump sum it would be taxed at 25%. Thereafter when any income is taken from the remaining £75,000, it would be taxed at the individual’s marginal rate of tax.
Q: An Issue not talked about so far is how the new pension freedoms will affect long term care provision. How do you think the changes will impact that?
A: If the client taking income from their pension needed to go into long term care and they decided to cease to take that income, the income will still be included in the assessment on the grounds of the estate deprivation rules. .
If the pension fund is not paying an income when the individual goes into long term care then there’s a concern over whether the fund could be included in the assessment for long term care under the new freedoms. The charging for residential accommodation guide covers pension income but not the underlying fund. There’s a question over whether a local authority could force someone to encash their pension and take the money. A ruling on a recent bankruptcy case (Horton v Henry) saw the trustees in bankruptcy not being allowed to force an individual to take their pension rights. However, we will have to wait and see if there is a legal challenge in the future specific to pension funds being assessed for long term care. Advisor should raise it with clients as a potential future risk.
Q: I’ve been told by one provider that if you had a husband and wife and the husband nominates the wife then they both die, the only option is to pay a lump sum to the children. Is that the case?
A: No. The last person nominated can nominate a successor. However in this scenario where husband and wife died together and there was no further nomination, the scheme administrator, assuming there are no further dependants, could nominate a nominee to receive the death benefits, i.e., non-dependant children. The issue thereafter is what the scheme rules allow; there is nothing in the legislation precluding the recipient from designating the fund as a flexi-access drawdown fund or taking the death benefits as a lump sum. It may be the scheme rules dictate that only the latter is payable, but this is not a legislative condition. Presuming both options are available under the rules, the scheme administrator would go to the chosen beneficiary and ask them how they want it paid, lump sum or flexi access drawdown.
However, it could go to grandchildren and great grand children meaning you could end up with 8 separate pension funds and the question then is how commercially viable it would be to run those, particularly if the pot was small to start off with.