Will my family be able to take full advantage of the new “Pension Freedoms” ?
From my time working for a large pension provider in the UK, in the majority of cases, the answer is no.
Since April 2015, following changes to the regulations, pension death benefits have become so much more flexible. One of the key changes was to allow the pension plan to be passed on death to non-dependant beneficiaries. Adult children not in full time education are normally classed as non-dependant. Previously a non-dependant could only receive a lump sum payment, however now the death benefit payment can remain in a pension plan in the name of the beneficiary. This means the beneficiary will maintain the tax advantages that a pension offers – tax free growth, and no Inheritance Tax on their death. Added to this the beneficiary has flexible access to all the pension fund from any age, tax free where the original pension plan owner died before their 75th birthday.
On death after age 75 however the death benefit is taxed as income in the hands of the beneficiary. If only a lump sum death benefit can be paid it is likely that a large proportion of the lump sum will be taxed at 40% and possibly 45%. Having the option of the beneficiary inheriting the pension plan means you can control when you take the income and therefore when and how much income tax you pay.
So why are so many non-dependant beneficiaries unable to have this new option? This is because either the pension policyholder has not made a nomination of beneficiaries to their pension provider, known as an expression of wish; or if they have, the wording in the expression of wish is too prescriptive to allow this flexibility. Death benefits can only be paid as a lump sum to a non-dependant, unless they are specifically named on the expression of wish in which case they are also able to choose to inherit the pension plan.
Where an expression of wish has been made, from my experience, it will typically request the pension provider to pay the whole fund to the spouse. This may be fine if the spouse needs the pension death benefit for their future income, however what if the spouse does not need all or some of the death benefit? Perhaps they may already be well looked after through other assets in the estate, and would rather their children or grandchildren receive some or all the death benefit? If the provider decides to pay the benefit to the spouse as per the instructions in the expression of wish and the spouse asks for payment to be made to somebody else, such a redirection could potentially be classed as an unauthorised payment and taxed at 70%.
Often we do not know for certain today exactly how we would like our pension fund to be distributed on death. Most of us want to ensure our loved ones are properly looked after, but we also want to ensure there is choice and flexibility at the date of death? Perhaps you want to ensure your spouse has priority in receiving the death benefit, but also that your non-dependent children can also benefit if the spouse does not need all money? If you would like the benefit to go to more than one person, do you need to specify proportions today? Would setting up a trust be a better option for your particular circumstance?
The new “pension freedoms” have given us greater choice and better protection for our family in respect of pension death benefits. However, many people are not able to fully benefit because they have not reviewed their nomination of beneficiaries, or are yet to make a nomination. Making sure your family are able to take full advantage of the new rules is not always that straightforward, and perhaps best done with assistance from a profession adviser.