True inter-generational planning?
In the pre-2015 rules, the death of an individual pension holder meant that the death benefits were often paid out of that pension plan to the chosen beneficiary. In many cases this was seen as just a deferral of IHT – husband passing the money from his plan to his wife, and then when she died, IHT could be due if her estate exceeded the threshold.
The new rules are fundamentally different – the money remains in the pension plan for the use of the chosen beneficiary and then potentially the next beneficiary. If used correctly it is a real family trust for generations yet to come.
The nomination can be made by the current pension scheme beneficiary, whether the scheme member or, after their death, the current beneficiary, or, in certain circumstances, the scheme administrator.
The taxation of payments from the pension will depend on the age at which the previous pension beneficiary died. If they were under 75, benefits will be tax-free if paid within the ‘two-year window’. If 75 or over, there will be marginal rate income tax payable.
Tax
After the pension freedoms changes, the last piece of the picture was a change to the tax on death. In something of a surprise move, the then chancellor George Osborne removed the punitive tax charge and introduced the new regime.
These rules apply to all ‘money purchase’ arrangements, irrespective of whether they are ‘crystallised’ or ‘uncrystallised’.
As it now stands, benefits paid on death before age 75 are tax-free (as long as designated within two years) and those paid on death after age 75 are payable at the recipient’s marginal rate of income tax. This could be particularly efficient if benefits are paid to a non-taxpayer who should be able to draw up to the level of personal allowance tax-free and perhaps better than being paid to a higher-rate taxpayer.
It is also important to consider any lifetime allowance charge. Unless a pension scheme member has the appropriate protection (individual, fixed, primary or enhanced), the benefits that can be paid from their pension scheme, including death benefits, in excess of £1m for 2016/17 will suffer a tax charge.
This charge will be 55 per cent on a lump sum payment or 25 per cent on funds used to make (taxable) income payments.
Inheritance Tax
Under the previous registered pension regime, for death benefit payments to be free of IHT the scheme administrator/trustees had to retain discretion as to who should benefit on the member’s death.
HMRC has confirmed that the nomination of a dependent, nominee, or successor by a pension scheme member or beneficiary under the new rules will not cause them to be treated as making a transfer of value for IHT purposes on death, as long as the member/beneficiary does not have power under the scheme’s rules to irrevocably choose the beneficiary who should be entitled to death benefits on his/her death; and the administrator/trustee maintains a discretionary power to choose who should receive death benefits.
