Pension death benefits

Transcription

1 Pension death benefits Adviser guide For adviser use only.

2 Section 1 Contents What do the pension death options mean for advice? Page 03 What s changed? 03 What will this mean for advice? 03 Option 1: Inherited drawdown 04 Option 2: Bypass trusts 04 Is inherited drawdown always the best option? 05 Section 2 What needs to happen? 05 Deciding who gets what 05 Can the existing pension scheme do it? 05 The importance of reviewing nominations 06 Case study: George and Brenda 06 Nominations to a bypass trust 06 Do it now Right pension? 2. Right Nomination? 3. At the right time? Spotlight on: Pension death benefits 02/07

3 Section 1: What do the pension death options mean for advice? The pension benefits rules mean that pension pots are far more inheritable than ever before, meaning clients can consider using their pension pot as a vehicle to pass wealth down through the generations. What s changed? The rules have introduced two significant changes to DC pension death benefits. What s different? Who can benefit What does it mean? Lump sum death benefits can continue to be paid to any nominated individual or trust. No change there. But the rules no longer restrict a continuing pension income to a dependant. Pension savings can now be passed to any nominated individual (not a trust) to draw an income from, while remaining in a tax privileged pension wrapper via an inherited drawdown fund. Once a drawdown fund has been created for a nominated beneficiary, they can access the pot at any age, drawing as much or as little as they choose. And they can nominate their own beneficiaries to inherit the pension pot on their death. This allows pension wealth to be cascaded down the generations, with fully flexible access, and without ever forming part of an estate until it is paid out. The tax they pay Age at death now determines the tax treatment of pension death benefits. There is no longer any taxation distinction between benefits provided from crystallised and uncrystallised funds (other than the potential need for an LTA test on death before age 75 against the latter). On death before age 75, any pension death benefits can be paid free of income tax. This includes any nominations in favour of a bypass trust. Aged 75 and above, the beneficiary pays income tax on the money they draw, whether this is taken all in one go, or as a series of income payments. So, depending on a beneficiary s tax status, benefits could be taxed anywhere between 0% and 45%. Careful planning on how much income to take each year, in conjunction with income from other sources, can therefore minimise the tax that has to be paid. Note that bypass trusts cannot be nominated for income, and so can only benefit from a lump sum, which will always be taxed at 45%. For individuals, the same tax treatment applies to both income and lump sums provided on death. What will this mean for advice? So much has changed that it will require a reassessment of what clients would like to happen to their fund. Will it be better to leave pension wealth to a nominated beneficiary via an inherited drawdown arrangement? Is a bypass trust still an attractive option for passing on pension death benefits? The answer to these questions will of course come down personal circumstances. And the choice needn t be either or. For example, a client can request that part of their fund on death is nominated to certain family members for drawdown, with the rest paid into a bypass trust. But it helps to fully understand how the rules could impact on the decision making process: 03/07 Spotlight on: Pension death benefits

4 Option 1: Inherited drawdown Previously only a dependant could carry on in drawdown following the death of the pension scheme member, but now it s possible for anyone to be nominated to inherit the drawdown fund. So for the first time pension wealth may be passed to adult children within the pension wrapper rather than as a lump sum, and there is no requirement for them to wait until they reach age 55 to access it. The tax benefits of this option are threefold: 1. The fund remains invested in tax free environment with income and gains free from income tax and Capital Gains Tax (CGT). 2. The pension fund also remains outside the beneficiary s estate for Inheritance Tax (IHT) and doesn t count towards their own pension lifetime allowance (LTA). The fund can continue to remain in the pension wrapper even after the beneficiary s death as they too can nominate a successor. 3. The tax on income withdrawals is determined by the deceased s age on death. So initially, it will be the age of the member at date of death that determines how their beneficiaries are taxed. Subsequently, it will be the age at death of the beneficiaries that determines how their chosen successors are taxed. And so on. a) Where death occurred before 75, the beneficiary has a pension pot which they can access at any time which is completely tax free. b) For deaths after 75, withdrawals will be taxable at the beneficiary s marginal rate. But unlike taking a lump sum, the beneficiary may be able to limit the tax payable if withdrawals are taken over an extended period rather than the whole amount taxed in a single year. Option 2: Bypass trusts Traditionally, a popular way of passing on pension wealth tax efficiently has been the use of a bypass trust, whereby the pension death benefit lump sum is paid to a discretionary trust from which family members can benefit. They are often referred as spousal bypass trusts as one of the key benefits allowed the spouse access, at the trustee s discretion, but without it forming part of their estate for IHT. While this has probably been the most common way that these trusts have been used, reference to spouse is a bit of a misnomer, as access can be given to any of the trust beneficiaries with the same tax consequences. But now access and the ability to keep the funds outside the spouse s or any other beneficiary s estate can be achieved through the inherited drawdown option. If this was the primary purpose of setting up the bypass trust, a review of whether it is still appropriate going forward will be necessary. Where death is after age 75, the amount going into the bypass trust will suffer a 45% tax charge. It is possible for the beneficiary to reclaim this tax via self-assesment or using form R40. Another feature often connected with bypass trusts is the possibility for the trustees to grant loans to a beneficiary. If the beneficiary spends the money, as would be anticipated when making the loan, the loan must be repaid from their estate on death, therefore reducing the beneficiary s estate for IHT. A loan payment to a beneficiary is typically not taxable and would not be treated as an exit from the trust. When comparing the merits of bypass trusts against inherited drawdown it is important to factor in that there will also be tax charges on both income and gains on the investments within the trust which would not arise if the money is retained within the pension wrapper. Spotlight on: Pension death benefits 04/07

5 Is inherited drawdown always the best option? It s not quite as simple as that, as tax isn t the only motivation for using a bypass trust. Controlling who ultimately benefits from their pension wealth will be an important consideration for many clients. A bypass trust puts a client s own chosen trustees in charge over who benefits, and when. The trustees can be guided in the decision making by a letter of wishes from the deceased. This control from beyond the grave may be a comfort for complicated family structures, where there are children from previous relationships or vulnerable family members who are dependent on the member. Inherited drawdown will in most circumstances provide more tax-efficient and simple wealth transfer options than a bypass trust, but the inherited fund could be withdrawn and spent by the nominated individual, or ultimately nominated to another successor whom the original member would not have approved of. Section 2: What needs to happen? Clients hoping to leave a flexible legacy to family members from their pension need to check that they have everything in place to make that happen. Having the availability of the full range of death benefit options from a modern flexible pension and keeping nominations updated as part of regular client reviews has increased in importance. And the time to do it is now; as tomorrow could be too late. This table gives an at a glance overview of the flexibility available under our different pension products. Aside from our Wrap SIPP and SSAS, our pensions do require percentages for system and record purposes. = flexible = not flexible Individual SIPP family (Wrap SIPP, Active Money SIPP) Individual non-sipp family (AMPP, PP, IP, SHP, FRP, FSAVC) Workplace Contract-based family (GSIPP, GFRP, GPP, GSHP) Workplace Master Trust family (MasterTrust, StanplanA CIMP/ EPP) Workplace Own Trust family (TBP, CIMP, EPP, RAP, GAVC, AVC, SSAS) Old-style Individual family (RAC, buy-outs, FSSU/N) Clients have full access to new flexibility Beneficiaries have full access to flexible death benefit options Clients and beneficiaries have easy access to new flexibility in all circumstances Access to full flexibility is by transfer or upgrade at retirement or death The employer or trustees decide the degree of flexibility available for members Easy access is available in all circumstances if the employer or trustees wish to offer it Clients must normally transfer to access the new flexibility No access to flexible death benefits Deciding who gets what The changes to pension death benefit rules should be the prompt for many clients to stop and think what they would like to happen to any remaining pension fund on their death. The merits of each of the possible options need to be considered. Are the client s loved ones best served by the tax efficiency and flexibility of the inherited drawdown rules, or is a secure fixed income from a survivors annuity more appealing? Would a lump sum paid to a family member be better directed to a bypass trust where their chosen trustees can control who benefits and when? Just some of the questions which will need answered. But having determined what clients would like to happen, focus needs to turn quickly to making sure those wishes can be followed. Can the existing pension scheme do it? The first test is to see if the preferred option is available within their current pension scheme. Although the rules can be applied to all DC pensions, not every DC pension scheme is set up to facilitate them. For example, there will be a number of older schemes which cannot offer inherited drawdown and the only income option for someone dying in such a scheme may be an annuity. It s not just a question of how death benefits can be paid where they can be paid is also important. For example, anyone who would like their death benefits paid as a lump sum to a bypass trust will need to check that their current pension allows this. 05/07 Spotlight on: Pension death benefits

6 Dying while stuck in the wrong pension scheme may mean the client s preferred option isn t available and in some cases there may be no option at all. This could result in unnecessary tax being paid by the beneficiary. And it will most likely be too late to put things right. This means it may be necessary to transfer benefits to a scheme which can accommodate their preferences where clients place importance on the destination of death benefits. The importance of reviewing nominations Even where the pension offers all the freedoms, it s important to make sure that pension nominations remain up to date and fully reflect the client s intentions. Providing us with a split of how you would like the death benefit paid would be helpful for Standard Life to understand your intentions. A death benefit nomination helps to guide the scheme trustees/administrators when exercising their discretion. The scheme trustees/administrator will be guided by the last instructions they have received, so it is vitally important that nominations are regularly reviewed. If changes are necessary, the nomination can normally be changed at any time. The rules allow for someone who is not dependent upon the deceased to draw an income. But crucially the scheme trustees/administrator cannot exercise their discretion and offer them the inherited drawdown option where there s also a dependant unless the deceased had nominated them during their lifetime. Therefore, this is a good incentive for clients to review and update their nominations. Case study George and Brenda George and Brenda are married. George has a grown up daughter Lindsay from a previous relationship. George dies and his SIPP administrators have to exercise their discretion to determine how to pay out the remaining fund in George s SIPP between Brenda and Lindsay. They could: 1. Pay out a lump sum to Brenda and/or Lindsay. There are no restrictions on how they exercise their discretion over a lump sum. 2. Set up an inherited drawdown plan for Brenda as she is a dependant. 3. As there s an existing dependant they could only set up an inherited drawdown plan for Lindsay if George has previously nominated her. Nominations to a bypass trust Issues can also arise where clients have set up a bypass trust and completed a nomination for the lump sum to be paid in to it. Some nominations to a bypass trust can be made binding upon the scheme administrator. In such cases the scheme administrator has to pay to the bypass trust and no longer has any discretion to pay to anyone else. Although nominations can be binding they can be revoked simply by completing a fresh one. In light of the changes clients will need to determine if a bypass trust is still the right solution for them. If not, the only cost to the client is the initial amount used to set up the trust, usually a nominal amount of say 10. Remember, laws and tax rules can change in the future. Standard Life accepts no responsibility for any advice given based on this information Do it now It s easy to think that planning pension flexibility can be left until close to retirement. But effective planning needs to ensure the needs of the client, and their loved ones, are catered for in any circumstance including the premature death that nobody wants to think about. Transferring to a flexible pension when health starts to fail can remove all IHT protection from the transferred pot. So do it while your client is still healthy. And dying with an out of date nomination may mean the remaining pot can t be passed to the right beneficiaries, or in the most efficient way. Review nominations now and make it a standard part of your annual client review. As circumstances change, nominations should change to adapt. Spotlight on: Pension death benefits 06/07

7 Pensions Savings Investments Insurance Find out more Call us on We re open Monday to Friday, 9am to 5pm. Calls may be monitored/and or recorded to protect both you and us and help with our training. Call charges will vary. Standard Life Assurance Limited is registered in Scotland (SC286833) at Standard Life House, 30 Lothian Road, Edinburgh EH1 2DH. Standard Life Assurance Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. GEN Standard Life Aberdeen, images reproduced under licence. All rights reserved.