Pensions are attractive to many due to their tax efficient nature. After all, tax relief is applied upon contributions turning £8,000 into £10,000 in an instant, furthermore higher and additional rate taxpayers can claim further tax savings currently in line with their marginal rates. Once invested, the growth in the pension will also be free from personal income and capital gains tax and when the time comes to withdraw funds, one of the options currently available, allows you to take up to 25% of the pension funds as a tax free lump sum.
Another current attractive tax aspect that pensions provide is upon death. Funds held in a pension are not included in valuing someone’s estate for Inheritance Tax (IHT) purposes. This means that pension funds are therefore not subject to a 40% tax payable on an estate in excess of the Nil Rate Band. Right? Well, sort of, maybe….?
Example: A married couple with children
As with many aspects of financial planning, the answer isn’t always a simple yes or no. To help illustrate this let's look at the example of a married couple with children. They own their £350,000 home outright, have a second property worth £150,000 and savings and investments worth a further £300,000. This brings their combined estate value to £800,000. As they have wills and plan to leave their estate to their children they are currently well within their combined allowances of £1m.
They each have pensions worth £400,000 and have nominated each other to receive the value of their holdings should they die. In principle this is ok, however, IHT consequences could arrive if they haven’t checked their pension plans as to how the death benefits are paid out. Under pension freedoms introduced in 2015 the death benefits from pension schemes can be paid out in essentially two ways;
Paid as a lump sum, or;
By way of a nominee flexi-access drawdown
Whilst current legislation allows for either method, some providers and their pension schemes do not and will only pay the proceeds out by way of a lump sum with no flexibility. This is because whilst pension legislation changed it did not compel the providers to amend their pension contracts.
So coming back at our couple following the death of the first person who died before they had accessed their pension. This pension, which in this instance is still an old style contract, pays out the value of £400,000 tax free, as they are aged under 75, to the surviving spouse. The deceased made no use of their IHT allowances, which are inherited by the survivor who now has assets of;
House
£350,000
Rental Property
£150,000
Savings/Investments
£700,000
Total
£1,200,000
This now means that on the death of the second spouse, 40% tax is due on the value of holdings above £1m therefore, assuming the value of the estate remains at £1.2Million, the estate on second death will face an £80,000 IHT bill.
IHT, like many other taxes could have been avoided by taking some simple measures. Had the couple reviewed the death benefits on their pension arrangements by engaging with a regulated financial adviser, then action taken prior to the death of the first partner could have helped to avoid this outcome.
At Armstrong Watson, our quest is to help our clients achieve prosperity, a secure future and peace of mind. We can provide a full review of your pension arrangements, with our compliments in the first instance, to help you to understand, based on your individual circumstances and arrangements, the position with regards to your current pension plans and whether this is an area you need to consider
For further information or advice, please email Stuart Smith or call him on 07590 205 918.
