How to protect your pension after you die
Death and taxes – not the most pleasant of subjects but please bear with me! From a financial perspective, it is crucially important that all the i’s are dotted and the t’s are crossed – the last thing a grieving family needs is more stress following the loss of a loved one.
It is common for people to think that once the will is in place then that’s it, their assets will go to their chosen beneficiaries, but that would potentially be missing one of the largest sources of wealth an individual can own – their pension.
Before I go any further, if you do not have a will, drafting one should very much be a priority.
The rules regarding intestacy in Scotland are complex, divided into “prior rights”, “legal rights” and the free estate.
Not something you want to take a chance on, so please consult a solicitor.
Going back to pensions, one of the most common misconceptions regarding pensions in the UK runs along the lines of: “What’s the point, as when I die the insurance company will just keep it all?”
Given the frequent changes to legislation and the rather, let’s say, non-complimentary press-coverage, this feeling is perhaps somewhat understandable.
However, after a few simple checks, it is fairly straightforward to prevent any remaining pension fund disappearing into the insurance company void.
For some context, let’s fly back to 2015 – doesn’t seem like four years ago does it? Back when the “B” word wasn’t a constant background buzz.
That year saw some significant changes to pensions legislation, more commonly known as the pension freedoms.
One of the most interesting changes was the increased ability of an individual to tax-efficiently pass their pension fund to anyone of their choosing.
The rules now allow an individual to nominate a successor who can inherit the balance of their money-purchase pension scheme, also known as the death benefits.
This successor does not have to be financially dependent on the pension member.
The key number regarding pension death benefits is the age of 75. If an individual dies prior to this milestone, the pension funds pass to the successor and can be withdrawn free of income tax.
If a person dies when they are over the age of 75, any withdrawn funds are taxed at the marginal rate of the recipient.
The good news is that, regardless of the age of death, the pension will pass to the next generation free of inheritance tax (IHT). Or will it?
One of the more subtle things to consider regarding the 2015 changes, is that while the updated rules were put in place for new pensions, they were not imposed on existing policies.
In other words, that old pension you have from years ago, quietly growing year after year, may not be able to be passed on in the most efficient way.
For example, some older pension schemes allow only a “return of fund” option on death.
Now, that sounds like the right outcome, but it is actually the exact opposite.
Most often, return of fund will see the pension paid back into the estate of the deceased. What this means is that the funds may then be exposed to IHT, at the hefty rate of 40 per cent – which is really not the best outcome.
Much more preferable is to use the option of dependant, nominee or successor drawdown.
This allows the assets to remain in a pension environment, pass free of IHT, and then either be withdrawn as required or stay in the very tax-efficient vehicle of a pension.
So, while our minds naturally head to the drafting of a will when considering who will inherit our assets, we should also give some thought to our pension savings.
It is not unusual for people to have made a nomination when the pension was first established, which no longer reflects their wishes.
Reviews and good planning can ensure we make full use of the very generous current pension options, particularly when we want to help out the younger generation.
Fraser Porter is chief executive officer at Anderson Anderson & Brown Wealth.