The introduction of what is commonly referred to as ‘Pension Freedom’ on 6th April 2015 not only changed the way you can access your pension pot if you have built up a retirement fund in a Private (defined contribution) Pension Plan but also how it can pass to your beneficiaries.

Who can inherit my pension fund?

Collectively referred to as beneficiaries, those who can benefit from your pension after your death are as follows:

If you do not know who your beneficiary is, you should contact your pension provider to check. If you don’t have a named beneficiary or you would like to change who would currently receive your pension death benefits when you die; you can get in touch with your provider to request a nomination form or expression of wish form.

What options will my beneficiary have when I die?

Pension death benefits can be passed to your beneficiary in a number of ways:

• Lump sum payment:This is a single payment which will fully extinguish the pension fund
• Lifetime annuity:Your beneficiary can choose to buy an annuity which provides a guaranteed income for life
• Dependant’s or Nominee’s drawdown (Beneficiary Drawdown): Your beneficiary can opt to draw an income directly from your pension fund. This differs from the Lifetime Annuity option as it allows them to vary the amount of income they receive and the frequency of the payments. The trade-off is that the income is not guaranteed as the pension fund remains invested.

More about beneficiary drawdown

There is no limit to how many times a beneficiary drawdown plan can be passed on to a subsequent beneficiary following your death.

The cycle of passing on to a subsequent beneficiary can continue until the pension funds are exhausted. This makes such arrangements very useful as a means of passing wealth to the next generation in a very tax efficient manner.

How is my pension fund taxed when I die?

The age at which you die determines how your pension fund will be taxed when it passes to your dependants or nominated beneficiary.

Generally, if you die before your 75th birthday your pension fund will pass to your nominated beneficiary free of income tax and they will be able to take a withdrawal (either as a lump sum or a regular income) without paying tax.

If you die on or after your 75th birthday your beneficiary can still choose to take the pension fund as a lump sum or enter a beneficiary’s drawdown arrangement but they will pay income tax on any money they withdraw.

Most pension plans are free from inheritance tax (on death at any age). For the fund to be free of inheritance tax any nomination you have made needs to be revocable – this means that it cannot be a binding instruction.

Some of your pension fund may also be subject to inheritance tax if you have moved money between pension plans in the two years before your death at a time when you knew you were in poor health and may have a reduced life expectancy.

If you would like to know more about this particular issue feel free to get in touch and speak to one our experts.

Death benefits and the lifetime allowance

If you have built up substantial funds in your pensions during your working life and have not taken any benefits from them and subsequently die before your 75th birthday your defined contribution pension funds and any defined benefit lump sums will be tested against your Lifetime Allowance.

This is the amount of savings that can be built up in a tax-advantaged environment and the current allowance is £1,073,100.

Any pension funds which exceed the Lifetime Allowance will be subject to a Lifetime Allowance tax charge of either 25% or 55% on the excess value; the amount payable depends on how the excess funds are accessed by your beneficiaries:

• If they take the excess funds as a lump sum they will pay a 55% tax charge on the excess amount only
• If they have chosen beneficiary drawdown the excess fund will be taxed at 25%.

A Word of Caution

The options that will be available to your beneficiary are very much dependent on:

• The type of pension plan you have: Retirement Annuity Contracts and Section 32 Buyout plans typically have less flexibility when compared to a Personal Pension or a Self-Invested Personal Pension (SIPP)
• Your pension provider: Different pension products have different rules and some contracts, such as Stakeholder Pensions, may not provide the full range of freedom options for your beneficiary
• The age of your pension: Older pensions will not necessarily be able to provide the same freedom options that a more modern contract allows.

If flexible pension death benefit options are important to you then you need to know what your pension plan can provide for your beneficiary as they may not be able to make use of your pension in the most suitable or tax efficient manner for them if their options are limited.

At The Private Office we have many decades of experience helping people manage their pension wealth and putting into place effective strategies for passing wealth on to future generations.

The Financial Conduct Authority does not regulate Tax Advice or Estate Planning.

If you would like to ensure that your pension plans provide the maximum flexibility for your family when you die or would just like to know a little more get in touch with us or you can arrange call with one of our financial advisers here.

We’re currently offering those with £100,000 in pensions, savings or investments the opportunity for a free initial consultation, up to the value of £500, to map out your financial future. Using cash flow forecasting we can show you if you’ll have enough for a comfortable retirement and the small steps you can take that may make a big difference to your outcome.

Important: If you are a member of a defined benefit (final salary) scheme the pension freedom rules will not apply to you. This article only relates to defined contribution. If you would like to understand more about what benefits your scheme will provide when you die please get in touch.