For decades, inheritances and pensions operated the same way. You worked in a good job for years and you were given a pension in the form of a final salary style pension, or you might have taken out an annuity.
Then, if you were married and one of you died, the surviving spouse would receive half of it.
If both spouses died, then maybe your children would get the pension residually for a guaranteed period of around 10 years, and then it would disappear.
However, now with the fantastic new pension rules that have come out thanks to George Osborne and the pension freedoms in 2015, that is no longer the case.
The introduction of flexible access drawdown pensions
Now, pensions are not only efficient on death if they remain invested, but actually offer much better returns if you convert them into a flexible access drawdown pension.
With a flexible access drawdown pension, you’re no longer buying annuities because they don’t pay as much in comparison to these new drawdown pensions.
Also, flexible access pensions don’t tie up your money. With the older style annuities, if you happened to die in your earlier years, the pension company would keep the majority of your pension. However, that is not the case with flexible access.
With drawdown, you can pass your pension to your kids or any other named beneficiaries, tax free if you die before the age of 75.
If you happen to die after 75, it no longer becomes tax free, but can be paid out with income tax at the marginal rate.
The death benefits of flexible access drawdown
These drawdown pensions offer the best death benefits we’ve ever seen as not only can you pass down your whole pension to your spouse or the next generation, but your pension is also free of inheritance tax, subject to lifetime allowance limits.
As long as you don’t draw all of it out in one go, of course.
Let me give you a quick example:
Most of the time, the biggest risk to your pension is death in your early years. If you decide to take your pension from the age of 55 (which you can do now), if you were to then die at 56 with an old annuity style plan, you’ve lost the majority of your money. The pension company would keep it.
However, with a flexible drawdown pension, anything left in the pension that’s less than a million pounds and is within the lifetime allowance can be paid out completely tax free.
So, if the recipients want it paid out, there is no inheritance tax; and if they only take out what they need from the pension pot, and then, if they die before 75, what’s left can be passed down tax free to the next generation too.
Because of these great death benefits, this money becomes incredibly useful for inheritance tax planning.
An incredibly efficient pot of money
Another fantastic thing to keep in mind is that this money is also completely outside of your estate.
This means that if you are a wealthy individual or couple with hundreds of thousands or perhaps even millions of pounds of assets outside of your pension, there’s no point using the pension at all!
The rest of your assets are more than likely subject to a 40% inheritance tax but your pension isn’t.
This means that you have a pot of money you can access that is so efficient, you don’t even have to tie it up for seven or so years like you would in a trust.
Also, we don’t have to speculate with huge amounts of risk and invest it into potentially riskier alternative investment market shares where you can only see the money (free of inheritance tax) after two years.
Protecting your family’s inheritance is about using pots of money that you have built up from years ago in the most efficient way possible. If you have other assets from which you can draw income down, and which are subject to large amounts of inheritance tax, the flexible access drawdown can be very efficient indeed.
The rules don’t apply to every pension – consult your adviser
As fantastic as these new flexible access pensions are, in order to fully take advantage of these benefits you must consult an independent financial adviser.
Just because the rules are out there, that doesn’t necessarily mean they will apply to your pension. Most pensions have been built up with decent pots from years ago and they may not have the most modern death rules applied to them such as the multi generational benefits.
In order to access these new rules with all the new death benefits, you may need to make a transfer to a newer, flexible access pension.
In pensions, your money is hidden behind barriers of regulation and, most of the time, you can’t move this money around on your own.
There are all sorts of regulations and restrictions for pension pots larger than £30k which mean that they can’t actually be moved without an adviser’s written authority. So, ultimately, it’s always worth consulting someone you trust, who is an experienced independent financial adviser, before making any major decisions on your pensions.
I hope this has been useful, and if you have anything else to add, I’d love to hear from you. To find out more, feel free to get in touch by emailing firstname.lastname@example.org.
The views expressed in this article are those of the author and do not constitute financial advice. Applewood Independent Ltd is authorised and regulated by the Financial Conduct Authority. For financial advice designed for you and your specific circumstances, please contact the author using the contact details provided in this article or, alternatively, contact the Applewood Independent Ltd office on 01270 626555.
The value of your investment can go down as well as up, and you may not get back the full amount invested.
Past performance is not a guide to future performance.
Accessing pension benefits is not suitable for everyone. You should seek advice to understand your options at retirement.