The Family Pension

Under the recent pension legislation changes, private pension wealth can be passed on to other family members, in some cases completely tax-free. For those looking to manage investments for the next generation, this is an eye-catching opportunity. It opens up the concept of the pension family tree. Children or grandchildren can inherit your pension, and if you die before the age of 75 they will not pay tax on the withdrawals they make from it (the same applies if each beneficiary dies before age 75).

How can wealth pass down a pension family tree?

New pension rules change how pensions are taxed on death, and who can inherit them. Under the old rules, once you had started to draw your pension then anything paid out to your surviving beneficiaries was subject to income tax if taken as income, or a 55% flat-rate tax if taken as a lump sum. In the case of income, this could only be paid to someone financially dependent on you, for instance a spouse or dependent child.

Under the new rules, regardless of whether you have started to draw a pension, your remaining fund can be passed on tax-free, if you die before the age of 75.

Your nominated beneficiary can use it to provide a tax-free income or a tax-free lump sum, and no longer needs to be financially dependent on you. If you die on or after the age of 75, the beneficiary can receive the pension, subject to tax at their marginal rate if taken as income or as a lump sum taxed at 45% (expected to change to recipient’s tax rate from next year). Pensions usually fall outside an estate, and thus are free of inheritance tax.

The Chancellor has made it possible to pass pension wealth on in a more tax-efficient manner. But don’t forget tax rules can change in future. The average life expectancy at age 65 in the UK is 87 for men and 89 for women (Source: Office for National Statistics), so the government estimates most people will survive the age 75 threshold, and thus bring in tax receipts when they die.

How do you set up a pension family tree for your own family?

You simply nominate to whom you would like the remaining pension paid when you die (and can nominate more than one person), via a simple expression of wish form.  You can change the nomination at any time. The nomination is not legally binding, however it does alert the pension administrator to your wishes. Nominated beneficiaries and dependants can choose whether they take an income or lump sum.

Spousal Bypass Trust

For those individuals who wish to exert more personal control over the future direction of their pension funds on death it may be more appropriate to consider leaving the capital to a trust on death.

As is common with wealth preservation and inheritance tax planning Individuals need to consider the key factors of flexibility, tax and control when deciding the most appropriate route for them. Taking advice from an appropriately qualified lawyer and financial adviser is recommended.

Decisions should also be reviewed on a regular basis; a key date for review of nominations is just prior to a pension holder’s 75th birthday.

This article is based on our understanding of current and draft legislation, which could change in future. The Financial Conduct Authority does not regulate tax advice or trusts. This represents our understanding of law and HM Revenue & Customs practice as at May 2015.