A new pension dawn is looming as the pension freedoms take effect this April.  Two of the key changes include:

• The opportunity to pass on an individual’s pension fund to anyone; and
• Changes to the taxation of pension death benefits.

Currently, only a dependant of the member such as a surviving spouse perhaps being the most common example, can choose to take a pension following the member’s death.

From April, this will be extended to include non-dependants. This will allow children of all ages, grandchildren and unmarried partners to take a drawdown pension. They in turn can nominate someone else to benefit from any remaining pension fund on their death, and this can keep on happening, until the pension fund is exhausted.

So, as well as the member and their beneficiaries being able to flexibly access pension funds, a pension fund can be seen as an effective mechanism for passing on wealth through the generations.

All well and good so far, but we need to consider the tax situation. Is there a catch? On the face of it no would seem to be the answer.

• Currently, a lump sum death benefit (LSDB) paid by 5 April 2015 will be taxed at 55% where the member dies aged 75 and over, or if their pension fund is crystallised. Otherwise, the lump sum will be paid tax free.
• From 6 April 2015, a LSDB paid by 5 April 2016 will be taxed at 45% if the member dies aged 75 and over.
• For lump sums paid from 6 April 2016, it’s proposed that tax will be levied at the recipient’s marginal rate of income tax.
• Where the member dies before reaching 75, the LSDB should be paid tax free. It will not matter if the fund is crystallised or not.
• Where the member dies and the recipient takes an income starting before 6 April 2015, it will be taxed at the recipient’s tax rate.
• If the first payment is delayed until after 5 April 2015, it and future payments will be tax free where the member dies under age 75.
• Where the member dies aged 75 and over, pension payments will be taxed at the recipient’s marginal tax rate.

Where a pension fund passes on following the death of a beneficiary, the subsequent payment of a LSDB will be taxed based on the age of the deceased beneficiary, not the member.

That’s the facts and figures so let’s look at how these changes might work in practice.

Sam died on 5 January 2015, aged 81 and is survived by his wife and 2 children, Alex and Sarah, both of whom are in their forties. Having left his non pension assets to his wife, he had completed an expression of wish requesting that the scheme administrator consider applying the pension fund for the benefit of Alex and Sarah.

As beneficiaries, they requested the provider delay paying death benefits until after 5 April 2015 to benefit from the new pension rules. Both elected to take a beneficiary’s flexi-access drawdown, with Alex drawing income from his fund at his marginal tax rate. Sarah, on the other hand, took no income and died in March 2016; being survived by her two adult children, William and Harry. As Sarah died under age 75, her sons could take a lump sum or pension free of tax. William decided to take a lump sum to use as a deposit for a flat, whilst Harry elected for flexible access drawdown and used the tax free income to supplement his employment income.

The pension freedoms will undoubtedly offer excellent tax planning opportunities for both the member and their beneficiaries, with pension funds being an effective and tax efficient mechanism for passing on wealth through the generations.

The new changes to pensions provide a great deal of choice, however what is clear is that pensions have never been more complex. Given the range of options now available, the need to seek professional advice is therefore so important. Please contact your Cullen Wealth consultant who will be able to assist you with this complex area of advice.

This article was written for us by Neil MacGillivray who is head of James Hay Partnership’s Technical Support and also Chairman of AMPS (a trade association for member-directed pension schemes)