This week we were delighted to host a seminar focusing on pensions.
We were pleased to be joined by guest speakers Morag Robertson of Brewin Dolphin and Robert Darling of Standard Life Wealth together with our own pensions partner, Juliet Bayne and Nicola Kerr, an associate in our Family Law team as well as myself.
Each of the speakers looked at different aspects of pensions given the recent significant changes. The audience participation was high with many questions to the speakers afterwards.
Pensions and Estate Planning
The recent pension changes have resulted in a change of tack in terms of estate planning considerations. Given the changes to death benefits there has been a review again as to whether trusts are still thought to be useful in this area.
It is even more important than ever for advisors to work extremely closely together when advising clients and it is clear that specialist advice is crucial in this very complicated area.
A quick reminder of the changes
If you die before age 75 then pension death benefits can be paid tax free. If you die after age 75 the beneficiary pays income tax on the funds that they take out, whether this is taken all in one go or in a series of income payments.
Therefore, benefits can be taxed anywhere between 0% and 45%.
The previous position
What is known as “spousal by-pass” trusts were frequently used. The idea was to prevent death benefits falling into the surviving spouse’s estate on death if they weren’t required. Passing those funds into a trust meant that on the second spouse’s death these would not form part of their own estate from inheritance tax.
Some post-April 2015 commentators, have suggested that trusts may not have the same benefits as before. However, trusts are still a significant tool in terms of estate planning.
Benefits of use of trusts
In each individual circumstance it is necessary to consider the merits of paying lump sum benefits out of the pension arrangement or leaving them in the scheme.
If a member dies under age 75 then there will be no tax charge on the death benefits paid however they are paid. If the member dies at age 75 or over then for the tax year 2015/16 those age 75 or over will suffer a tax charge of 45%.
The payments made in the tax years after 2015/16 will be taxed at the marginal rate of the tax of the recipient beneficiary. For payments made to a trust the tax rate will be 45%.
However, there is a provision in the Finance Bill (yet to come into force) that a beneficiary of the trust can benefit from that 45% attributed tax credit on any payments that are subsequently made out of the trust where the payment to the trust was made on or after 6 April 2016.
Therefore, this can be attractive for lower or non-rate taxpayers (such as grandchildren). Therefore, although benefits paid as a lump sum to a trust may suffer a greater initial tax charge then it may be possible to recover some of this initial tax liability when payments are later made out of the trust.
It is also necessary to consider individual beneficiary’s circumstances. If a scheme member has died and the fund is designated to a new dependent or nominee then it is their subsequent age that then determines the subsequent taxation of death benefits.
It may well be worth considering whether it is worth getting the funds out into a trust when it is tax free if the pension scheme member dies under the age of 75.
If a beneficiary has drawn down all of the pension fund or received a lump sum then these death benefits will form part of their taxable estate for IHT purposes. They will also be exposed potentially to claims from spouses, creditors and local authorities. The trust would ensure, on the other hand, that these funds are excluded from the beneficiary’s estate.
Family circumstances can be complicated. Payments of death benefits via flexi access drawdown may not be acceptable for many who either have young children or have perhaps married again for the second time and want children from the first marriage to benefit.
The use of a trust in these circumstances means that the trustees will make the decision over who benefits rather than existing beneficiaries and the scheme administrators.
As always it is necessary to compare and contrast the different tax considerations.
Money held in the pension fund will continue to grow tax free. If funds are transferred to a trust then the funds will suffer the usual income and capital gains tax liable to trusts. It is also necessary to consider the ongoing inheritance tax charges for trusts.
Each individual circumstance is different and no one-size fits all. It is necessary to get bespoke advice in each circumstance. On balance it may be thought useful to have a trust in place with a suitably worded letter of wishes to the pension scheme trustees to direct that they make over funds taking into consideration the family circumstances and tax considerations at the relevant times.
Never was obtaining specialist advice so crucial. It is also absolutely clear that advisors must work very closely together to ensure the best advice is given in all cases.
On November 13, 2015