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Older style pensions increase tax on death

20th April 2017

We would all like to imagine that we will live to a ripe old age. For all of us when we die the value of our assets that we leave behind is called our estate. Part of that estate is potentially subject to Inheritance Tax at 40%, a sizeable chunk. The funds left in pensions would not normally be included in your estate for this calculation but if your pension plan is an older plan you should take immediate steps to check the options on death. Here's why...

A client recently came to me who had very sadly lost her husband at an early age. The husband had significant pension funds built up throughout his career with different pension plans. Three were with one pension provider and a further fund with another provider.

As you might expect, the two older plans which had been in existence for longer were the largest by some way. The providers of these plans said the only option they could offer was a lump sum benefit paid directly to the beneficiaries, in this case the surviving widow. This would have increased her estate by the value of these two pension funds, being over £600,000.

With their main residence and other assets, plus the pay out from these pension funds the widow’s estate now sits at £1.4M. Even with the new main residence exemption if she now dies the Inheritance Tax bill will be a minimum of £160,000, possibly much more.

In contrast the two other pension plans which were more modern and allowed the option to move the pension funds on death into 'Beneficiaries Flexi-Access Drawdown' in the spouse’s name.

With this option the benefits are as follows:-

  •  The funds remain in the pension wrapper and so are not inside her estate.
  •  The funds continue to grow in a capital gains tax free and income tax advantaged environment.
  •  The surviving spouse may draw on the benefit and, as death was before 75, this will be entirely tax free (death after 75 means benefits are taxable when drawn).
  •  As and when she subsequently dies the funds can be passed to her beneficiaries, being her three children, within the pension wrapper, free from Inheritance Tax, and can continue to 'cascade' through to future generations.

There is a critical difference between the treatment of the first two pension plans and the second two.

I was surprised that the same pension provider offered different and detrimental options depending on the age of the plan.

It takes one telephone call to each of your pension providers to establish whether your existing plans offer the Beneficiaries Flexi-Access Drawdown option on death.

If the option is not available then you please call us to discuss what to do next.