PENSION DEATH BENEFITS AND THE ADVANTAGES OF USING A TRUST
Released On 22nd Apr 2022
Most of us can look forward to many years of retirement and use pensions as a tax-efficient way of saving for life after work, so it’s important to be aware of what happens to a pension fund upon death. Changes to tax rules and the pension freedoms mean a pension fund can be left to loved ones on death, normally free of inheritance tax.
Careful thought needs to be given to who should inherit a pension fund. In broad terms, if death occurs before age 75, normally a pension fund can be passed on tax-free. If death occurs on or after the 75th birthday, a pension fund becomes taxable in the hands of beneficiaries, at their marginal rate(s) of income tax. If a pension plan offers the full flexibilities of the “pension freedoms”, the pension fund can stay in the pot and be passed on to others on subsequent death, affording tax planning. However, if the pension freedoms are not applicable to the plan, options are limited to using the fund to purchase an annuity or to pay out the entire fund as a lump sum. This can, unfortunately, result in the fund being no longer held in a pension wrapper which can have unintended consequences.
Regardless of whether the pension freedoms are available or not, when family circumstances are complex, involve multiple marriages, young people and/or a substantial pension fund, it might be better to use a Trust. On death, the pension fund is paid as a lump sum death benefit to a Trust.
When could using a Trust could be beneficial?
Providing for a spouse – If the pension fund is paid out as a lump sum to a spouse, on their subsequent death any remaining funds will form part of their estate and could be subject to inheritance tax. On remarriage and subsequent death, the inherited pension fund might end up with a completely different family. Using a Trust can still provide for a spouse during their lifetime as well as ensure the residual fund is kept in the family upon death. Where the full range of options permitted under pension freedoms is available, the option of taking the death benefits via flexi-access drawdown ensures ongoing inheritance protection as well as other advantages.
Provision for children/grandchildren under 18 - Divorced or separated parents naturally want to pass their pension on to their children but not give the ex-spouse control of the child’s pension fund as they will have parental control of the child’s finances. Setting up a Trust means the Trustees are responsible for the funds in the trust.
Control over the way benefits are taken – How would you feel about giving financially inexperienced beneficiary access to a large sum of money? A Trust means that access to funds can be restricted and avoids the situation of an 18-year-old taking a large fund in cash.
Care home fees – If a spouse has inherited a pension and placed those funds in drawdown, even if no funds are withdrawn, once they reach state pension age the income that could be purchased with the fund is taken into consideration by the local authority when assessing assets and income (before state pension age, only actual withdrawals are taken into account). If the pension money had been paid to a Trust instead, it can’t be considered whilst it remains within the trust - however trustees can help to pay for the care if needed. Any income/capital paid from the trust to the beneficiary can be taken into account for means-testing.
You should always seek financial planning and legal advice to put your pension death benefits into Trust.
The Financial Conduct Authority does not regulate Trusts.
