HOW TO GIVE AWAY YOUR PENSION – AND MAKE IT EASIER FOR YOUR HEIRS TO SPEND IT
Your pension is not just a means to fund your retirement – it’s the fruit of a lifetime of work, and it is important to plan what happens to this legacy after you die.
Many people’s financial planning will focus on what happens to their home, savings and other assets that make up their estate – but pension savings can easily slip the net when it comes to making plans for when you’re gone.
This is important, since your pension can be a key way to reduce or even eliminate inheritance tax; while estates that exceed the tax-free nil-rate band are taxed at 40pc, anything left in your pension pot when you die can be passed on IHT-free.
Here, Telegraph Money breaks down how to make sure your pension goes to the right people, how they might be able to use it, and how they can limit how much tax they pay on it.
Make sure you name a beneficiary
What happens to your retirement savings depends on what type of pension scheme you are enrolled in. In a defined contribution scheme, which invests your money, you can nominate as many people as you like to inherit your pot, or part of your pot.
The person you name is known as a “beneficiary”. You can make a note of your beneficiaries in an “expression of wishes”.
This form can be drawn up to accompany your will (it’s a good idea to make sure your pension plans match in both) – and most pension providers will have a form in place ready for you to fill out.
]The administrators and trustees of your pension scheme will refer to this form when you die, but note that it’s not legally binding.
There are a few instances where a pension provider might not follow an expression of wishes. Sean McCann, of the wealth manager NFU Mutual, noted that the pension provider also has discretion on who to pay death benefits to: “They will complete their own investigations, but will normally follow the instructions in the nomination unless there is a good reason not to, such as deceased leaving dependents that have not been adequately provided for,” he said.
You do not need to make any alterations in advance of making an expression of wishes, such as setting up a Sipp. The pension provider will automatically make a plan for your beneficiaries.
If you have a defined benefit pension scheme, your heirs won’t receive a pension lump sum – however your surviving spouse could then take over receiving your pension income, or a nominated beneficiary (though they usually need to be a dependent).
Now read: The bizarre tax rules you must not break when passing on wealth
Check how the pension will be passed on
In most cases, each beneficiary is given a few options about what to do with the pension money they inherit. The first option is to receive it as a cash lump sum. They can also leave the money in a “beneficiaries drawdown account”, from which they can take pension income or lump sums when they wish, otherwise the money stays invested.
While most pension schemes offer a lump sum death benefit, and many do not provide the option of a beneficiary drawdown.
You will need to check the options available to your beneficiaries with your provider – especially since the beneficiary drawdown option can be particularly helpful for passing down pension savings for years to come.
Option for passing wealth down the generations
Earlier this year Chancellor Jeremy Hunt abolished the pensions lifetime allowance, which previously capped tax-free pension savings at £1.1m. This means there is effectively no limit on the overall amount of money you can build up in pensions over your lifetime, and they are usually free of inheritance tax.
Michelle Holgate, of the wealth manager Brewin Dolphin, said using this to your advantage could make a huge difference to your children or grandchildren’s financial future.
“If you die before age 75, benefits left in a defined contribution pension can be paid as a lump sum, annuity or received into a pension in a beneficiary drawdown plan with, in most cases, no tax to pay. If you die after age 75, a lump sum or annuity will be taxed at the beneficiaries’ marginal rate of income tax.
“However, if you choose beneficiary drawdown, tax will only be payable when income is drawn from the inherited fund, such income can be drawn at any age,” she said.
“Therefore, as long as the funds stay in beneficiary drawdown, they will remain IHT-free and income tax-free. This means you could pass on your pension to your children, who could then pass it on to their children, who in turn could pass it to their offspring, raising the prospect of pension money cascading down the generations.”
Now read: Eight ways to avoid paying too much tax in retirement
You’ve inherited a big pension – now what?
Once you inherit a pension, the simplest option is to leave it invested in the stock market. However this means it could both fall and rise in value, so if you need to retire soon or are planning to use the money within the next few years, it might be better to cash out the pension sooner rather than later.
If you want to be more hands-on with how your pension is invested, you could also transfer the money into a “self invested personal pension”, or a Sipp.
Here you can choose what funds and stocks to invest in yourself, much like you would in a stocks and shares Isa. You can find our guide on how to choose a Sipp provider here.
Finally, you could opt for a guaranteed income. If you are of retirement age, then you can buy an annuity, which guarantees an income for life. Annuity rates are much higher now than they have been in more than a decade, thanks to higher interest rates. But this does not mean they are necessarily good value – you can find out more in our guide to annuities.
Now read: Six easy (and completely legal) ways to avoid inheritance tax
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