Keep It in the Family: Taxation of Pensions, Part 1

By 24th February 2015

This article was originally published on Quadrant Group’s website. Quadrant Group was acquired by Progeny in March 2017.

Have you ever watched the game show ‘Keep It in the Family’? Three generations of rival families do battle for some large prizes – a family holiday, a brand new car and some lesser rewards, such as a year’s supply of pizza. My teenage daughter especially likes that the youngest generation makes all the big decisions such as which of their team plays the game and which prizes the family can win. My favourite bit is a group of grannies with a combined age of 486 that gives clues to things in pop culture and the family teams have to guess what they are talking about to score points. I admit this part is a little close to home, but that’s another story!

Like the game show, many of us want to keep our wealth within the family to provide the best for our parents, children and grandchildren. In fact, most of my clients are ‘family stewards’. They want to provide for the next generation but also support those in need today. The latest amendments to the Taxation of Pensions Bill firmly positions flexible pensions as the estate planning vehicle of choice.

Tax relief on contributions without the seven-year wait for them to be outside your estate and tax-free investment returns are already a good reason for people to fund pensions for oneself and family. Now combine these with the new rules where a flexible pension, such as a SIPP or a Family SIPP, allows pension wealth to cascade down the generations within the pension wrapper and we have a truly tax-efficient wealth management and inheritance plan with few peers.

I came up with my top 10 advice points for ‘family stewards’ wishing to pass on their accumulated pension wealth, ensuring as much as possible is kept within the family. As there is so much to consider in this age of pension simplification, this week I am outlining the first 3 of my top tips. The next 7 points will be published soon – subscribe to our newsletter to receive them in your inbox!

1. Wealth Transfer Vehicle

Revisit your Estate planning strategy if your primary concern is maximising what can be passed on. The previous wisdom of stripping out funds and gifting the surplus income to minimise the impact of the current 55% tax charge has given way to retaining funds within the pension as a more tax efficient solution.

Retaining pension wealth within a pension fund and passing it down to future generations is an extremely tax efficient Estate planning solution. It has the benefits of:

  • being Inheritance tax (IHT) free
  • Tax free investment returns
  • Potential for some beneficiaries to receive tax free withdrawals.

The new rules will necessitate some pension members to nominate an individual to inherit the remaining pension fund as a ‘nominee’s flexi-access drawdown account’. This can be anyone at any age and is no longer restricted to your ‘dependants’. Adult children who have long since flown the nest can now benefit and don’t have to wait until 55 to access it.

If the original member dies after age 75, any withdrawals will be taxed at the beneficiary’s marginal rate. But if death occurs before age 75, the nominated beneficiary has a pot of money they can access at any time, completely tax free. In either case, the funds are outside the beneficiary’s Estate for IHT while they remain within the drawdown account and will continue to enjoy tax free growth.

2. Pass it on and on and on…

Review pension arrangements – your existing pension arrangement must be able to offer the nominees’ and successors’ drawdown accounts. Some pensions may only be geared up to offer a lump sum death benefit, which would lose the protection of the new pension rules for IHT and any income tax payable would have to be paid in a single tax year.

The ability for beneficiaries to pass on and on pension wealth doesn’t stop there. The nominated beneficiary can nominate their own successor who will take over the fund following their death – unlike the current rules where lump sum death benefits are the only option for non-dependants.

This will allow accumulated pension wealth to cascade down the generations, whilst continuing to enjoy the tax freedoms that the pension wrapper will provide.

3. Tax rate determined by age at last death

On death before 75, it’s worth considering skipping a generation with at least some of the pot, to ensure a tax-free inheritance for the children. With a 94% chance that at least one of a 65 year old couple will live to at least 80, routing all the wealth via the surviving spouse means it’s likely any subsequent inheritance to the children will be taxable.

Each time a pension fund is inherited by a nominee or successor, the tax rate will be reset by the age at death of the last drawdown account holder.

For example Joe, a widower, dies age 82 having nominated his son John to receive his flexi-access drawdown fund. As Joe died after age 75, John is taxable at his marginal rate on any income withdrawals. John sadly dies age 70 and leaves the remaining fund to his daughter Jenny. Jenny can take withdrawals from her successor’s drawdown account tax free as John died before 75.

You can see from the above that even these three starting items will be great for you and your family. It is however important to ensure you are not caught out and your money goes exactly where you want it to go.

Quadrant works with clients to create life and financial plans that are reviewed each year in a holistic and structured way. Clearly, we keep up with regulation changes and revisit strategies and pension plans to ensure that clients remain on track.

Contact us to see how we can help you plan for your future.

Learn more next week about keeping your pension in the family in part two of this blog. Subscribe to our newsletter to make sure you don’t miss it!

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This article does not constitute financial advice. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner to take into account your particular investment objectives, financial situation and individual needs. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections.

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and the value of investments can fall as well as rise. No representation is made that the stated results will be replicated.

Andrew Pereira

Director, Wealth

Andrew has been working with families, high-net-worth clients and business owners for well over 20 years.

Learn more about Andrew Pereira