Pension Benefits: Why You Should Pay into a Pension

There are many pension benefits, such as:

• Obtain tax relief at your highest marginal rate on contributions (up to age 75)
• The pension fund grows free of tax
• Generally, exempt from IHT
• 25% of the fund can be withdrawn tax free
• Death benefits

If we focus on death benefits, a question which many of us do not consider when thinking about the value of our pension is; what happens to my pension when I die?

Naturally, individuals focus their attention on the ‘here and now’ such as; investment performance, investment strategy and cost. However, there could be consequences should your pension arrangement not be up to date with The Freedom & Choice reforms introduced in 2015. As such, pensions are vital when planning for your future as a drawdown plan can now be considered an effective inheritance tax (IHT) planning vehicle. This is one of the major pension benefits and should be carefully considered.

Many pensions, should they not be up to date with the Freedom & Choice reforms and remain uncrystallised (a pension which has not been accessed) will typically pay the proceeds as a lump sum to said beneficiary upon death. The lump sum will either be; tax-free if death occurs before age 75, or, taxable at the beneficiary’s marginal rate if death occurs after age 75.

Pensions can be deemed to be outside of your estate for IHT purposes. Therefore, should a pension pay out a lump sum upon death, this will be moving the proceeds from an environment which is free of IHT, into one which is not as it will now form part of the beneficiary’s estate. Alistair Cunningham, Financial Planning Director, explains more on the benefits of reviewing your pension’s death benefits.

Looking at an example, we have clients John & Julie Wingate, both 80 years old, married with two children; David and Danielle. John dies with a pension fund of £200,000. If John’s pension was not up to date with the Freedom & Choice reforms, and is paid out as a lump sum upon his death, assuming Julie has no income, the payment of £200,000 would be taxed at her marginal rate, as follows:

£50,000 at 20%=£10,000

£100,000 at 40%=£40,000

£50,000 at 45%=£22,500

£72,500 income tax payable

Julie would lose her Personal Allowance of £12,500* as her income is over £125,000* (*for the 2019/20 tax year), therefore, the net payment from John’s pension would be £127,500. Upon Julie’s death, the funds would form part of her estate and potentially liable to IHT at 40%.

Pensions which are up to date with the reforms will offer complete Flexi access drawdown inclusive of beneficiary drawdown, This means that on death, the pension can be retained within the pension environment indefinitely and passed down through generations, continuing to make the most of the pension benefits due to them being invested into a tax-free environment.

If we look again at our example of John & Julie but this time, John’s pension does have a beneficiary drawdown option. Again, John nominated Julie to receive the pension fund on his death, but this time Julie opts to retain it within the pension, thus IHT free. Julie subsequently nominates her beneficiaries as being David and Danielle in equal proportions. Julie dies five years later, so David and Danielle inherit the pension fund, and both decide to retain it within the pension environment, again IHT free. They then nominate accordingly and so on…

Our example helps highlight the importance of ensuring your pension is appropriate, not only the ‘here and now’ but upon your demise. To understand who you can nominate your pension to, you might like to look at Ian Warrilow’s article on this subject. A tax bill can be minimised by staying up to date with pension rules and using the most appropriate vehicles available to you.

If this is an area that you would like to explore further with Wingate Financial Planning, please contact me directly and I would be happy to arrange a no-obligation meeting to see how I could add value and assurance when planning for, and in, retirement.