It is increasingly clear that defined contribution pensions, and generational wealth planning, are inextricably linked, and fertile areas for financial planning.
Just as today we think about retirement planning rather than just pensions, the pensions freedoms act in 2015 was for many the catalyst leading towards the consideration of estate planning, rather than just inheritance tax (IHT). This was largely because the change to death benefit taxation for defined contribution pensions added a new perspective to funding retirement.
Given a frozen IHT nil rate band and property inflation, death benefit planning deserves an increasing higher priority, with an estimated £6.7 billion inheritance tax (IHT) collected for the year to March 2022. It has become more important than ever to ensure an expression of wish is not just in place but completed with thought to allow optimum efficiency.
As a reminder, until 5th April 2015, lump sums paid out post-75 were subject to an automatic 55% charge, as were lump sums from crystalized funds for death pre-75.
From 6th April 2015, commensurate with pensions freedoms and subject to the LTA, the benefit is tax free for deaths pre-75 and subject to beneficiaries’ marginal tax rates for death above that age.
In many instances, this change has led to transfers out of defined benefit arrangements as often more can be passed on to loved ones from one’s pensions than from other assets. Pensions are increasingly viewed as a tool to pass on wealth efficiently, not just to the immediate next generation but also to the generation after that. However, transferring out of a defined benefit/final salary scheme is unlikely to be in the best interests of most people.
Financial advice can play a key role in managing the process, aiding not only with the initial naming of beneficiaries but also providing support for periodic reviews and ensuring a more considered and thoughtful process behind decision making. For instance, the birth of grandchildren may influence the list of selected beneficiaries.
For lump sum amounts, potential beneficiaries include:
- Dependants
- Any other beneficiary nominated by the member
- Any other beneficiary chosen at the discretion of the scheme administrator.
For flexi-access drawdown:
- Dependants
- Anyone nominated by the member on their expression of wish.
Because the scheme administrator cannot use their discretion to give flexi-access to anyone else if there is a nomination on file or a dependant exists, it is crucial that the nominated members are not just the spouse or civil partner, if the intention is to cascade a pension through generations via beneficiary drawdown. For almost all scenarios, this being a better option than the beneficiary setting up a trust with their lump sum inheritance.
Furthermore, income taken from beneficiary flexi-access drawdown does not affect the beneficiary’s annual allowance or lifetime allowance, whilst the age of death of the nominee dictates the income tax position for their successor.
The value of pensions and investments and the income they produce can fall as well as rise.
You may get back less than you invested. Past performance is no guarantee of future returns.
Tax treatment varies according to individual circumstances and is subject to change.
The Financial Conduct Authority do not regulate tax advice or tax planning.
David Denton (FPFS TEP)
Head of TechnicalDavid is a Trust and Estates Practitioner. His primary role is to simplify, update and share technical knowledge, within the Quilter group, and the legal and accounting firms we and our clients work with.
This is to ensure that post-tax investment returns are maximised, despite complex and fast changing legislation impacting wealth management.