01 November, 2019
The introduction of pension freedoms in 2015 means that investors have a lot more choice over what to do with their pension savings. Whereas in the past the pension had to come to an end on death, now residual funds are allowed to remain in the protected pension environment for the benefit of the investor's beneficiaries.
Pensions offer significant tax benefits. Not only are there tax reliefs on contributions into the scheme, but the overall fund is not treated as part of the investor's estate on death for inheritance tax purposes. This had led to a large number of people considering their pension fund to be a major vehicle for passing wealth onto the next generation.
Whilst the freedoms are a good thing there are a number of potential pitfalls and misconceptions that people need to be aware of. The pension fund needs to be considered as part of the investor's overall planning and not in isolation. It is easy to create an imbalance where an investor's estate does not pass as they would have expected.
One main misconception for investors is that the destination of their pension funds will be covered by their Will. Most personal pensions are set up on a trust basis and so the decision as to what will happen to the residual pension fund will be made by the trustees of the pension scheme, not by the executors or provisions in a Will. The trustees will be guided by any nominations made to them by the investor during their lifetime. In the absence of any nomination, the pension trustees have a defined list of potential beneficiaries whom they can consider. For some investors, their preferred beneficiaries would not be included within this list and so it is imperative that a nomination is completed. In any event, it is good practice for investors to have looked at and considered carefully who they would want to benefit and to have completed a nomination form.
Investors are often surprised to discover the limited control that they can exercise over the ultimate destination of their pension funds. Whilst they are able to nominate beneficiaries who will benefit from their fund on their death, beyond that they cannot determine the destination of the funds. It will be for the current beneficiary of the fund to nominate their successors. For example, an investor who wishes their spouse to benefit from the pension fund after their death cannot state that the funds will then pass to their children on the death of the spouse. The destination of the funds will be determined by any nominations from the spouse and by the pension trustees. If the spouse were to remarry or if it were a situation where the investor had children from a previous relationship, it is easy to see that children could lose out. For some investors, this is not attractive.
If investors are concerned and wish to have more flexibility over funds, they could consider setting up a trust and nominating the trust as the beneficiary of their pension funds on death. Whilst this would take the funds out of the tax friendly pension environment, it would offer them the control and more flexibility on how the funds are used to benefit their family and beneficiaries after their death. This is a particularly attractive option for investors who die before the age of 75 when the funds can be paid out of the pension fund to the trust tax free. After that age, it is less attractive as it would be subject to a 45% tax charge (higher than inheritance tax). However, for some investors it may still be worth it to protect against the risk of children being "disinherited". It is also worth noting that it is not "all or nothing" and it is possible to nominate part of the pension fund to be paid out to such a trust.
For more information contact Victoria Motley in our Wills, Probate, Tax & Trusts department via email or phone on 01772 220022. Alternatively send any question through to Forbes Solicitors via our online Contact Form.