Bill Skinner is a Chartered Financial Planner at Evolve, based in Manchester. Bill has a number of clients for whom inter-generational financial planning is a key part of their approach to money. In this blog, Bill looks at the pension changes in April 2015 and how they might allow pension funds to pass through the generations.
Much of the recent comments on the forthcoming Pension reforms have focussed on the new freedoms available for taking benefits and the avoidance of having to purchase an annuity. This of course is a natural headline grabber. We have also seen debate over whether pension plan holders will be sensible enough to avoid the temptation to’ spend, spend, spend’ and the obvious ramifications for the State if they run out of money too soon.
What has not been so well commented on are the changes to the position on death and in particular the ability to pass a pension fund on to subsequent generations. As the rules stand at present where a pension plan holder dies after they have started to take the benefits, the funds can pass to a spouse, civil partner or financial dependent. The list is quite limited and an important point to note is that the children are not included as possible beneficiaries.
Contrast this with the position post April 2015. A pension holder will be able to nominate anyone to be the beneficiary of their pension fund. This means that children and even grandchildren will be able to benefit. So, the pension fund becomes a source of wealth that can be cascaded down the generations. Also, the pension fund is outside the estate for Inheritance Tax purposes.
With more and more families falling foul of Inheritance Tax, the passing down of pension funds could give a significant boost to subsequent generations. Beneficiaries will have the same choices for taking benefits as the original pension holder. However, withdrawals taken for an inherited pension will not be subject to tax if the original plan holder dies before age 75. If death occurs after 75, any withdrawals taken are taxed at the beneficiaries’ marginal rate from the tax year 2016/17 and at a flat rate of 45% for the tax year 2015/16.
For example, Joan draws on her pension plan when she is aged 65 and chooses not to buy an annuity so takes income withdrawals from her pension fund. She is widowed and nominates her daughter Fiona to be her beneficiary. Unfortunately, Joan dies a few years later when she is 73. Her daughter now inherits the pension fund and, as her mother died before age 75, any withdrawals Fiona takes are tax free. She can choose to extract the whole fund or take withdrawals to supplement her income. If Joan had died after age 75 any withdrawals would be taxable in Fiona’s hands.
Of course, Fiona can now nominate further beneficiaries of the pension fund for when she dies. Assuming there is still money left this will pass to those nominated in exactly the same way as when her mother’s fund passed to Fiona.
It is clear that this will be a major boost to the financial future of many families and that inter-generational planning will need to be discussed before decisions are made. For some the temptation to ‘cash in’ the pension fund will be great but for many there will need to be some thought given to leaving an inheritable fund for future generations which remains outside their estate for Inheritance Tax purposes.