When it comes to inheritance planning, one commonly misunderstood area is pensions. Passing on as much wealth as possible is a desire for many of us, but keeping pensions in the family might not be your first method of doing so. However, since the rules changed in 2015, defined contribution pensions can continue to live on through your family after you’ve gone.
As a pension sits outside your estate and is not covered by your will, it is often handled separately. From an inheritance planning perspective, this is great news as it won’t affect your IHT threshold. But, what happens to your pension when you die can differ depending on the type of scheme. Although defined benefit schemes (final salary pensions) tend to have their own rules, which the trustees set, most defined contribution pensions require a bit more planning and forethought on your part.
We recently looked at financial planning for blended families, so this time let’s explore how you can ensure that your defined contribution pension is passed on to your family members, not just once but potentially for generations to come.
Keeping pensions in the family
In 2015, pension rules were turned upside down with the introduction of Flexi-Access Drawdown. The ‘pension freedoms’ changed how a member of a defined contribution pension could take their retirement benefits and allowed more flexibility with death benefits.
Before then, the rules were complicated and restrictive, and only a ‘dependant’ could receive a taxable income from a pension on death. But now, the tax treatment is better, depending on the age you pass away, and a dependant, nominee or successor can continue to benefit from your pension savings:
- A dependant – includes a spouse or civil partner, a child under the age of 23 (unless they have a mental or physical disability), or another financially dependent person.
- A nominee – can be any individual nominated to receive death benefits, either by the original member, or the scheme administrator. This happens when there are no surviving dependants, people or charities nominated by the original member.
- A successor – is someone nominated by an existing dependant, nominee or successor to inherit the beneficiary’s drawdown; this allows wealth to cascade through generations and the pension to continue way beyond your lifetime.
To ensure that your money stays in the pension and that your nearest and dearest continue to benefit from the flexibility, you should make sure you’ve made a nomination and kept it up to date.
Usually, you would contact your pension provider and ask for a beneficiary nomination form, also known as an Expression of Wish, where you name the people you wish to benefit from your pension when you die.
With an up to date nomination, the money can be retained in the pension scheme after you’ve gone, which has tax benefits; staying outside of your estate for inheritance tax purposes and continuing to grow tax-free. It’s then in the beneficiary’s hands when and how they access the funds, so if they don’t need the money immediately, they can leave it in the scheme. And, what’s more, since 2015, if you pass away before age 75, the benefits can be taken tax-free by your loved ones. Although could potentially be subject to a Lifetime Allowance (LTA) charge after it’s tested against the original member’s Lifetime Allowance.
Whatever is left in the drawdown pot on the beneficiary’s death can be passed down to their successor, and so on. Meaning your pension pot can pass down repeatedly until it runs out.
Expression of Wish
Along with writing a will, an Expression of Wish is an important document and will be vital to keeping pensions within the family. If you have a pension, you are known as the original member of the scheme and would name those who you wish to benefit from your pension.
Here are three tips for writing and maintaining your Expression of Wish:
- Write clear detailed instructions, avoiding any general wording that could be misinterpreted. For example, instead of writing “our children”, name each child in case you have a blended family with children from previous relationships.
- Date the document and ensure a new date is added after every review.
- Review each year, especially after big life events, such as marriage, divorce or remarriage.
Unlike a will, the Expression of Wish is not legally binding. The final decision on how your pension is distributed is at the discretion of the pension trustees after the original member’s death. However, as with a will, your Expression of Wish or death benefit nomination should be checked annually to ensure no significant changes are overlooked. The older the document, the more chance it will risk being debated by the trustees.
Other things to consider
Once you’ve passed away, it’s out of your control what happens. The beneficiary you’ve nominated decides what to do with the inherited pension; they may want to take it all as a lump sum or prefer to secure an annuity to provide a guaranteed income, which means the pension may not pass down to future generations. But at least it’s been put to good use.
Interestingly, a beneficiary’s drawdown can be accessed at any age, even if they’re under 18. So, this is where controls, such as a trust, need to be brought in to prevent issues and provide certainty. And the same can be done for complex situations like blended families.
Also, you may find that not all defined contribution schemes offer beneficiary drawdown, or allow the contract to continue past the age of 75, so it’s always worth reviewing your pensions with a financial planner. And make sure your beneficiaries are involved throughout the process, their circumstances could change and it might not be that they can easily receive the benefit. Say for example they decide to live abroad, your pension provider might not open a beneficiary drawdown policy for an overseas resident, at which point your plans could become unstuck.
Whether you are a couple with a small family or a large, extended or blended family, careful pension planning is vital to keeping pensions in the family and ensuring that your funds go to the right people when you pass away.
If you need a pension review or you have a complex family situation, and you’re worried about inheritance issues, get in touch with our independent financial planners.