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Getting pension and savings options straight

by
01 December 2016, at 12:00am

Dylan Jenkins provides an update on pension death benefit options and looks at the new Lifetime ISAs, due to come into effect in April 2017.

IN THIS ARTICLE I WILL PROVIDE AN UPDATE on the revised pension death benefit options as well as some further information on the new Lifetime ISAs (LISAs) that will come into force in April 2017.

A recap on pension death benefit options

I have mentioned in previous articles that there are a number of options for the payment of your pension fund on your death and these offer enormous opportunities for tax planning and efficiently passing wealth down through generations of your family.

I will just mention that these rules are applicable to money held in pension funds and may not apply to occupational defined benefit schemes or annuities that are already in payment.

Firstly, I will summarise the basic rules:

  • Death benefits can be paid to any beneficiary (older rules were far more restrictive). 
  • Where the deceased is under 75 and the death benefits are designated to a beneficiary within a two-year period, benefits will usually be paid free of all tax. 
  • Where the deceased is over 75, or if the death benefits are not designated to a beneficiary within two years, benefits will be subject to tax.
  • On the death of a beneficiary, any remaining funds can be passed on again. It is the age of the beneficiary at the date of their death (i.e. whether they were aged over or under 75) that dictates whether funds are taxable, not the age of the original member. 

Those eligible for pension death benefits will have the option of leaving the money invested and drawing a pension under the new flexi-access drawdown rules. This means they can take income as and when required, with no limits and no need for reviews. This presents a huge opportunity for wealth and estate planning. 

There are some interesting points to note about these rules – and an important one relates to who can receive the death benefits. 

There are no restrictions on the type of beneficiary who can receive lump sum death benefits, so a lump sum can be paid from the pension on your death to anyone you have nominated or anyone the Trustees determine should benefit (this is important, for example, if you had not made any nomination). 

This is all well and good, but if you are over age 75 at the time of your death the lump sum is taxed as income when it is paid out from the pension, so if this is all paid out in one year it may prove very inefficient from a tax perspective, and this lack of option does not enable efficient planning.

It may be much more efficient and desirable from many viewpoints for a beneficiary to have the option to leave the money in the pension fund and receive pension income from the deceased member’s fund, not least because they can then be taxed on a small part of it annually to enable them to plan this more efficiently. 

There are just three classes of beneficiary entitled to receive pension income: 

  • A dependant – this is defined as someone who was a dependant of the original scheme member at the time of their death. Examples include a spouse or child under the age of 23, but it is restrictive, particularly for grown-up children who are no longer classed as financially dependent. 
  • A nominee – this can be anyone who has been nominated by the member.
  • A successor - anyone nominated by a dependant, nominee or successor to receive any remaining benefits on their subsequent death. Importantly, there is no limit on the number of successors, so in theory the fund could be passed on for generations if it is not all taken out. 

I will repeat that if a beneficiary does not fall into one of these three classes, they will not be able to receive death benefits as a pension – only as a lump sum – thereby potentially restricting the options open to them. A similar restriction applies after the death of a dependant, nominee or successor.

It is therefore more important than ever to nominate anyone you may want to be able to take a pension income from your fund after your death. You may think your spouse should have all of the fund, as they may need this. However, by nominating your children or a Trust to receive a small amount of (say) 1% of the fund each, this gives more flexibility.

The Trustees have the power to change the amounts providing the individual has been nominated. So in this example, after your death, if your spouse felt that in reality they did not need all of the fund and would prefer the children to have some bene t earlier in a tax-efficient manner, they can agree to increase the percentage paid to them, which would not be an option if they had not been nominated at all.

I have not covered the position here with regard to the interaction with the Lifetime Allowance as this is complex and may need additional considerations, and will not change the point that nominations in line with your wishes are vital.

The new Lifetime ISAs

The Lifetime ISA (LISA) is being introduced in April 2017 and is aimed at helping younger people simultaneously to save both for a first home and their retirement, without having to choose one over the other when starting to save.

It is widely felt that this may be a precursor to the abolition of pension tax relief, something we will just have to wait and see, so I will not speculate on that here!

The LISA will be available to anyone aged under 40. The individual will be entitled to save up to £4,000 in each tax year. The LISA investment forms part of the normal ISA subscription (which will be £20,000 from April 2017).

The government will add a 25% bonus on the contributions paid in a tax year at the end of that tax year and contributions with the government bonus can be made from age 18 to 50. So, if you invest the full £4,000 in a tax year, there will be a £1,000 government top-up (just like a pension).

You will notice that, although you can only start saving in a LISA before the age of 40, once you have started you can continue to receive tax benefits until age 50. In fact, contributions without any government bonus can continue after 50 – but this is just like any ISA at that stage so I do not see why an individual would use a LISA over the standard ISA for savings post-50.

LISA funds (including the government bonus) can be used to buy a first home up to £450,000 at any time from 12 months after opening the account. Any withdrawal going towards the purchase of a first property will be paid direct to the conveyancer along with the government bonus – this cannot be paid to the LISA holder or the bonus is lost.

Any withdrawals not related to a first property purchase can be made at any time but, if the saver is below age 60, the government bonus (together with any growth on the bonus) will be lost and a 5% charge will be payable.

From age 60, the saver is free to make full or partial withdrawals at any time tax-free and with no charge. If funds are left within the LISA they will continue to receive tax-free growth/income as for an ISA at present.

Savers will be able to contribute to one LISA in each tax year, as well as a cash ISA and a stocks and shares ISA, within the new overall ISA limit of £20,000 from April 2017.