Can I leave my unused pension to my loved ones?

The purpose of a pension is to provide an income in retirement. Until now, the Government, has never been keen on the idea that pensions could be a vehicle to pass down wealth to the next generation and have, until now, put measures in place to prevent this.

However, the Chancellor made a very welcome announcement of greater pension flexibility in the last Budget. These included the option to extract up to 100% of your pension pot in cash, with the first 25% tax free and the remaining balance taxed at your marginal rate.

We raised concerns in our summer newsletter that pensioners would be tempted to draw down all of the money and spend it on holidays, a new car and general improvements to their home, leaving little in the way of funds to support retirement. This is fine if there are other sources of income that can support you, but if not, poverty in retirement could be a very real possibility.

There was also the other issue of tax. In theory pension income, taken in lump sums or via a traditional annuity, could be managed so that tax is kept to a minimum. Taking vast sums all at once could result in a huge tax bill, and for what? To hold the post taxed cash in a bank account where it will scrape 1% interest if lucky, thus would effectively mean making a loss, and even then any interest will probably be subject to tax (unless you are a non-taxpayer).

More recently, the Chancellor has further expanded the Budget changes to include the removal of the 55% tax charge on pension lump sum death benefits.

Under the new system, anyone who dies below the age of 75 will be able to give their remaining fund to anyone, completely tax free, whether it is 'crystallised' (if any income or lump sums have been taken from the fund) or not, as long as it is paid out in lump sums, or taken through a flexible drawdown account (a pension plan that allows you to keep the balance of your pension funds invested and income to be taken if you wish). At which point it will be taxed at the individual's marginal rate.

The rules for those aged 75 or over are slightly different in that the funds can be inherited by a beneficiary who will then be able to draw down the fund at their marginal rate of income tax.

Any lump sums will suffer 45% tax rather than the former 55%. The Government intends to also make lump sum payments subject to tax at the marginal rate and will engage with the pension industry in order to put this regime in place for 2016-17.

These changes come into force in April 2015 and so if you should sadly lose a loved one between now and then, with pension funds and over the age of 75, it may be wise to consider deferring making a claim until April, to benefit from the reduced tax. We have spoken to a number of pension providers who have all confirmed that this practice will be acceptable to them, although any income payments would need to cease on death.

So whilst this may all be positive in terms of tax savings, we do worry that unsuspecting investors will fall into situations where their tax position is actually worse than it was before, and it will mainly be those individuals with larger pension pots. Perhaps this was the intention all along?

Anyone with pension funds exceeding the current Lifetime Allowance (LTA) of £1.25 million, will still have their funds taxed at 55%. In addition, anyone in receipt of pension funds could see their own LTA breached should the combined value of that which is inherited and their own existing fund exceed £1.25 million. Thus pushing them into the 55% tax charge through no fault of their own.

Luckily, anyone inheriting a pension pot that was protected, can benefit from that same protection, as effectively those funds have already been tested against the lifetime allowance of the original member. We realise this is complicated stuff and don't want to totally lose you but please note that there are still some creases for the Government to iron out here and we anticipate changes imminently.

Although not a vehicle to pass down wealth, the Government at least recognises that pensioners need a choice at retirement that may result in surplus funds on death. Why should these funds line the pockets of annuity providers when they could be passed to the deceased's loved ones. Obviously, this also means that HMRC gets its cut from the taxes imposed on these funds if taken post aged 75, or post 'crystallisation'. At least now, this is more in line with inheritance tax.

Again, it is vital to get proper independent advice tailored to you and your circumstances and be aware that legislation can change, so it is just as vital to ensure your plans are on track with regular reviews.