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Pensions death benefits
We have an insight from one of our Chartered Financial Planners, Lorraine Denton, into Pensions Death Benefits, an aspect of wealth transfer that the pandemic has brought to the fore of many clients’ minds. In this article, Lorraine explains the different options for nominating pension funds and maximising your legacy.
What are the pitfalls of not having your pension death benefits nomination up to date?
A reported increase* in people wanting to write or amend their wills at the start of COVID-19 (with some legal firms claiming a jump in demand of up to 76%) tells us that the pandemic has sharply focused people’s minds on making sure that their affairs are in order and that their wealth is transferred to the right beneficiaries should the worst happen.
A pension makes cascading residual wealth to loved ones and future generations possible and can be very tax-efficient, because many pension funds fall outside the estate of the plan-holder on death and do not suffer Inheritance Tax. Making nominations is important to ensure that your wishes to leave a legacy are clear. Without a nomination, the benefit options on death are significantly reduced.
In addition, accumulated pension savings are playing an increasing part in transferring wealth to future generations, with many savers now preserving their pension funds and taking an income from other savings first.
So as a Financial Planner, what am I looking to do for my clients? Firstly, prior to ensuring that my clients achieve the best outcomes for their remaining funds on death, it is crucial for me that their wishes are identified, and everything is in place to get money in the right hands with the least amount of tax payable. It is vital to ensure that a client has the correct type of pension scheme and that they are optimising their pension savings; only then do we check that their death benefit nominations accurately reflect their current wishes.
It is at this point that it is imperative to ensure that integrated death benefit planning takes place, and that decision-making concerning pension death benefit choices is coordinated with decisions taken about the will.
As Financial Planners, we build good relationships with other business professionals to ensure the best outcomes for our clients. By working together, the Financial Planner and Solicitor will look at all aspects and implications relating to your will and death benefits. This may involve us all meeting together to finalise the advice.
Inherit pension funds
Are you making use of the 2015 Pensions reforms?
What are the current options?
It's now possible for anyone to be nominated to inherit pension funds - not just ‘dependants’. For example, inherited Self-Invested Personal Pension Schemes (SIPPs) allow pension wealth to pass to anyone, including a non-married partner, and remain within the pension wrapper, available to them as and when they need it, rather than it being paid as a lump sum. And there's no requirement for them to wait until they reach age 55 to access it.
The landscape of pensions has changed in that clients are no longer using their pension as the primary source of income in retirement, ear-marking the pension as the legacy for future generations. They are instead spending their non-pension savings for income. This means that the pension pot remaining on death is potentially higher, having only been accessed once other savings have been spent.
Pension funds are IHT free
Accessing savings in this order means non-pension savings (such as ISAs, investment funds and bonds) are used to provide an income, reducing the amount of savings that may be subject to Inheritance Tax (IHT). This often leads to improved tax efficiency during the pension holder’s lifetime, because it may well be possible to receive an income that suffers less income tax than that which would have been provided by the pension. At the same time, pension funds - which are IHT free - are preserved. And they could also be paying less tax on their retirement income by best use of the tax allowances on offer.
In summary, the benefits from your SIPP/Private Pension pass free of IHT to the next generation or to a non-married partner, in contrast to most assets within the estate.
Does your pension contract allow the full flexibility that is now available?
A key consideration when discussing options with my clients is that not all pensions schemes can offer the full range of death benefit options. Some schemes have not adopted the full flexibilities, or don’t have the systems in place to offer them. For example, some older schemes cannot offer inherited drawdown, and the only income option for someone dying in such a scheme may be an annuity. Another option may be ‘return of fund’, which may not provide the client with the right outcome. This could mean a transfer to a more modern pension vehicle will be necessary to ensure my client’s future wishes are met.
When is the right time to nominate?
As nominations can be changed at any time, I don’t think there is such a thing as a ‘right time’. There are many aspects I consider with my clients to ensure that planning pension flexibility isn’t until close to retirement. I want to make sure that my clients and their loved ones are catered for in any circumstance - including the worst-case-scenarios, such as premature death.
Changes in personal circumstances, how much the client’s spouse may need in retirement, or reaching age 75 may all prompt a rethink on how benefits are to be distributed.
Is your pension your greatest legacy?
Do you leave everything to spouse/civil partner?
It’s common for many clients to nominate the whole pension fund to their spouse when they die; and when I refer to spouse, I also include civil partners. This ensures that the surviving spouse is provided for during the remainder of their retirement.
But there are several issues to consider before choosing this route, and it is important to consider each client’s circumstances. The reasons why a straightforward nomination to spouse only may not be the answer are highlighted below. There are two key areas for consideration: firstly, ensuring that the spouse has sufficient funds, and secondly (thinking of re-marriage), how we might protect the pension fund to keep it within the family blood line. The questions I am frequently asked are: what if my spouse re-marries once he/she inherit my pension fund? Or, will my children from my first marriage be protected?
Can my client afford to skip a generation?
Not every spouse will need the whole of the deceased’s pension fund. If a sustainable retirement income for the survivor can be achieved using just a portion of the deceased’s fund, then they may be comfortable leaving the balance to children or grandchildren on first death.
What about the future destination of inherited funds?
Most clients will trust their spouse to pass any unused funds on their death to their children. But what if there are children from a previous relationship? Or what might happen if their spouse remarries? Passing everything to the spouse means also giving them control over what happens to whatever is left when they die.
Control using bypass trust
I have some clients with more complex family situations, where control over who benefits is deemed essential. In these situations, clients may want to consider bypass trusts, from which the surviving spouse and future generations can benefit. This can ensure that the pension proceeds are kept within the family.
As a Financial Planner, it is becoming more apparent that we need to involve and educate beneficiaries as to how this could work for them, and ensure that they understand the tax implications once they inherit the pension, to avoid unnecessary mistakes. This area is full of intricacies, of which this article barely scrapes the surface - I haven’t covered taxation of pensions benefits, Lifetime Allowance, or any other options here.
So as you can see, there are many considerations and choices to make when planning how you might care for loved ones after your passing. However, with the right open discussion and a good financial plan, any family scenario can be catered for. It is certainly something that my clients very much value discussing sooner rather than later.
Our planners look at the entire financial picture and help make sense of complex and sometimes sensitive requirements.
* STEP Journal June 2020 / Law Society Gazette March 2020