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Passing on pensions tax-efficiently

Hurley Partners Director, Julie Sebastianelli, explains why clients need to get their pension scheme nominations in order.

Two years on from the legislation that changed the face of pensions, the Taxation of Pensions Act 2014, we are now seeing the practical effects on members and their chosen beneficiaries as deaths occur. And with this comes the realisation that not all pension scheme nominations were drafted carefully enough. Disappointment and/or unnecessary tax could be two of the unintended consequences.

What is important here? First, to ensure that any undrawn pension goes to the desired beneficiaries on death and secondly, in their hands the fund can be passed on in the most appropriate and tax-efficient manner.

Clients should be encouraged to review their nominations, keeping them up to date and fully inclusive of all potential beneficiaries. If nominations have not been reviewed since April 2015 this really needs addressing now.

Our summary below should be a useful reminder or update.

Who To Nominate?

There are three groups to consider as a beneficiary: Dependants, Nominees and Successors.

A Dependant can be a spouse/civil partner, child under age 23, dependant child over 23 or anyone else (at the time of death) who the administrator feels is financially dependent on the member. It’s worth noting that grandchildren are excluded, unless financially dependent.

A Nominee is an individual nominated by the member who is not a dependant.

A Successor is anyone nominated by: a dependant of the member; a nominee of the member; a successor of the member; the scheme administrator. The scheme administrator can only nominate an individual where there is no surviving dependant, individual or charity nominated by the member.

It’s always been the case that a dependant can receive a drawdown pension on the member’s death. Now, a nominee can also receive a drawdown pension. This is called nominee flexi-access drawdown. And on their death, a successor can take a drawdown pension, called successor flexi-access drawdown. The change means that funds can stay within the tax-efficient pension wrapper for a wider group of beneficiaries.

Administrator/Trustee powers to nominate

Consider these examples:

A member doesn’t make a nomination. He is survived by his spouse and his brother. The spouse is keen for some benefit to be paid to the brother. The Trustees can pay him a lump sum, but cannot offer him drawdown as an alternative, because he was not nominated by the member. The Trustees cannot nominate him because there is a dependant;

A member nominates his spouse but they subsequently divorce. He is survived by the ex-spouse and their adult children. The Trustees can take account of the divorce and pay lump sums to his adult children, but cannot offer the children drawdown as an alternative, because they were not nominated by the member. The scheme administrator cannot nominate them because the ex-spouse has been nominated by the member.

The key point here is that the dependant is treated differently from a nominee. And unless nominated, only a lump sum can be provided, not a drawdown income. This isn’t a big issue if the member dies before age 75 as no IHT or Income tax is chargeable in the hands of the beneficiary. However where death is at age 75 or older, taking a lump sum can be detrimental because it will be taxed as income in the hands of the nominee (or successor) and that could well mean a 45% tax charge. In both situations any lump sum paid leaves the tax advantaged pension wrapper and becomes part of the taxable estate of the recipient, which could increase any future IHT liability (on the death of the nominee or successor).

Lastly, if there is a surviving dependant or member nominee, and they wish to forgo benefits in favour of an unnamed beneficiary the scheme administrator wouldn’t be able to pay flexi-access drawdown to anyone else; only lump sums could be paid.

So while the legislation now allows drawdown for a much wider class of beneficiaries than pre 4/2015 it is important to consider the traps, if drawdown is likely to be beneficial. In summary, an administrator/trustee can appoint away from a dependant in favour of a non-dependant child (or indeed anyone within the class of beneficiaries set out in the Rules) for lump sum death benefit purposes. What they cannot do is set up nominees/successors’ drawdown for an un-nominated non-dependant in place of a dependant.

Making a Nomination

As a general rule, nominations need to be in writing and as specific and future-proofed as possible. Of course, they can be changed at any time, kept under review and reconsidered when circumstances change. Watch out particularly when a beneficiary dies before the member. At Hurley Partners we always review nominations with clients as part of our annual review process.

Many pension providers have now drafted their nomination forms more widely so that “everyone is a nominee”. In these circumstances it is probably best to use the form itself and to name the potential dependants/nominees required (even if no percentage is noted). This can then be accompanied by further explanation to guide the administrator/trustee in the form of a Letter of Wishes specific to the pension fund or funds.

The IHT position

As a pension is a trust and trustees have discretion as to whom they pay benefits to, (guided by a member’s nomination), the pension is IHT free and does not form part of the member’s taxable estate.

That is why we say that wherever possible your clients should know who their trustee is. For example with our Small Self-Administered Pension Schemes (SSAS), the pension scheme members are trustees themselves, together with Hurley Trustee Services as the professional trustee.

Bypass Trusts

Whilst another subject altogether it is worth considering any bypass trust that may exist as part of a product provider’s standard contract. Is it still relevant given the circumstances? Can it be changed and if so how? Particularly where a client is aged 75 or over such a trust might lead to a tax charge of 45%. This may be very unfortunate!

In Summary

Pension scheme nominations are a vital part of family wealth planning and go hand in hand with Wills and LPAs. They should be properly drafted (this may require expert assistance), and kept up to date if the chosen beneficiaries are to have access to all death benefit options available.

The attractions are:

  • Passing down wealth tax-efficiently through family generations within a pension wrapper.
  • Retaining funds within the tax-advantaged environment until such time as they are needed by the nominee or successor. Or if they are not needed, passed down to the next generation on the nominee or successor’s death.
  • Providing a flexible income to the nominee or successor as and when they need it. And if their predecessor dies before age 75, income payments are made tax-free.

Please remember – tax treatments are subject to change and their effect depends on individual circumstances.

To find out more on this subject visit www.hurleypartners.co.uk or contact Peter Collier at Hurley Partners on 020 8936 3970 or by e-mail – peter.collier@hurleypartners.co.uk

Hurley Partners strongly recommends that individuals should seek suitable professional advice regarding the matters referred to in this document, which has been prepared for general interest only. Nothing in this document constitutes advice. Hurley Partners Limited is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales No. 8401891. Registered Office; 12 Conduit Street, Mayfair, London, W1S 2XH. © Hurley Partners Limited 2018