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How pensions have become a key element of inheritance planning

‘In this world nothing can be said to be certain, except death and taxes.’ So said US Founding Father Benjamin Franklin, in a letter written following the establishment of the Constitution.

In pensions, death used to be followed by a huge 55% tax hit on any money you left behind to your loved ones. However, rules introduced last year mean it’s now possible to pass on your entire pension pot to your beneficiaries, tax-free.

How it works

Here’s how it works. If you have a SIPP and die before age 75, you can pass on your entire fund to your beneficiaries without them paying any tax at all. The money can be passed down as a cash lump sum, or transferred into a drawdown account.

If you die after age 75, the money you leave behind will be taxed at the marginal rate of the person you nominate to receive the money. So if your beneficiary has taxable income of £43,000 and receives an extra £10,000 lump sum from your SIPP when you die, they will only get £6,000 after tax. This tax bill can be minimised if the fund is left invested and withdrawn in smaller chunks as and when your beneficiary’s taxable income reduces in later life.

If your beneficiary dies before withdrawing the pensions bequeathed to them, they in turn can pass the funds on under the same tax rules. Indeed, it’s possible to have unlimited successors, meaning a pension can be passed on from generation to generation. You also don’t need to pass on your pension to just one person – you can nominate multiple people to get different shares of your hard-earned savings pot.

The reforms effectively mean pensions are now much more than simply a retirement savings vehicle – they are an inheritance tax planning tool as well.

The really important bit!

Unfortunately, pension providers are not mind readers, so you’ll need to fill in a SIPP death benefit and expression of wishes nomination form in order to make sure your retirement pot is passed on in the way you want. It will only take a few minutes but must be done if you want to make sure your money is distributed to the right people when you die.

Any unused funds must be ‘designated’ to your beneficiaries within two years of your death. This just means that the money needs to be transferred into the beneficiaries’ names.

So when it comes to pensions, Franklin’s maxim wasn’t quite right. Death may be certain, but taxes are not.


Tom Selby

Senior Analyst, AJ Bell

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