When clients think about passing an inheritance down to their children and grandchildren, their first thought is often about property or savings.
Indeed, recent research by Canada Life revealed that half of over-55s believe property would be the most tax-efficient asset to pass on as an inheritance, with just 6% believing their pension would be.
In the past, death benefits on pensions were often seen as complex and associated with punitive tax charges. However, since 2015 a lot has changed. The truth is now that death benefits in SIPPs (Self-Invested Personal Pension) have probably never been as simple, in terms of both the legislation and how benefits are taxed.
Writing in Money Marketing recently, Canada Life’s Andrew Tully said that “the potential for pensions being used as an inheritance is profound.” So, we’ve looked at how the rules regarding the treatment of death benefits in SIPPs has changed over the years, and the advantages offered by the current legislation.
While the laws and rules governing death benefits in SIPPs has probably never been easier to understand, this simplicity means that you have added considerations when advising how a client’s pension should be used as part of a client’s overall savings portfolio.
Increasingly, advisers are having the ‘save your pension until last’ conversation when talking to clients about generating income in retirement – something we’ll look at below.
From April 2006
Firstly, it will help for us to go back to April 2006 and revisit how death benefits were treated in the recent past.
- If a client died before taking benefits, lump sums from their fund could be paid to their nominated beneficiaries tax-free or used to provide income withdrawal via a SIPP or an annuity.
- If a client died before the age of 75 after taking benefits, the above applied. However, any lump sums from the SIPP were subject to a 35% tax charge.
- If a client died after the age of 75, benefits had to be used to pay a dependent’s pension. If there was no dependent, a lump sum could be paid to charity or someone who was not a dependent, although this would have been subject to a significant tax charge of 45% or more.
The rules subsequently changed to remove the requirement for the SIPP to be crystallised at age 75 (i.e. the tax-free lump sum had to be taken). However, if a client died after age 75 without taking benefits any lump sum death benefit would have been taxed at 45%.
From April 2015
Since Pension Freedoms were introduced, pension funds can now pass through generations:
- If a client dies before the age of 75, there is no tax to pay on the payment of death benefits from the SIPP, whether this is taken as income or the whole fund is withdrawn as a lump sum.
- If your client dies after the age of 75, any death benefits paid from the SIPP are taxed at the recipient’s marginal tax rate.
The beneficiaries receive the original SIPP member’s benefits. And, upon the death of the beneficiary (or beneficiaries), any benefits remaining in the SIPP from the original SIPP holder’s death can be further passed onto ‘dependent, nominees or successors’.
This gives you a great opportunity to use your client’s pension as a tax-efficient way of passing wealth onto future generations.
- There’s no requirement for investments in the SIPP to be sold on death. Assets can pass to beneficiaries, dependents, nominees or successors within the scheme. This is important for investments such as commercial property, particularly where the property is owned by your client’s business.
- The temptation for beneficiaries, dependents, nominees and successors may be to take significant lump sums on the death of a SIPP holder before the age of 75. However, this takes money out of the tax-efficient environment of the SIPP.
- Remember, SIPPs are not subject to Inheritance Tax (IHT). So, it may be more tax-efficient for clients to drawdown other investment vehicles (ISAs or other assets) and leave their pension intact. A recent Canada Life study found that only 32% of over-55s are likely to consider using non-pension wealth to generate income in retirement so their pension pot remains untouched.
- Even if your client dies after the age of 75, you have the ability to manage any withdrawals from the SIPP for beneficiaries, dependents, nominees and successors so this is done in the most tax-efficient way possible.
Note that the two-year rule is still important. Tax-free lump sum payments (where the individual dies before the age of 75) must be designated within two years of the scheme administrator being notified of the death of the individual. If not, these will be subject to a tax charge.
And, don’t forget that upon death there is still a test against the Lifetime Allowance. Any benefits in excess of the LTA once protection has been taken into consideration will be taxed in the usual way.
How do you pass on benefits through a SIPP?
An example would be for your client to nominate their spouse as primary beneficiary to their SIPP, but also to note down their children on the nomination form as people the Trustee can consider.
We have had scenarios where, on the client’s death, the spouse as beneficiary has waived their rights to the death benefits in favour of the children. As the children had been noted on the nomination form by the original client, the Trustee is able to pay income to the children as opposed to just lump sum death benefits.
This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice.
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