My wife and I are both retired with excellent private and state pensions which more than cover our lifestyle.

I am 74 years old. I also have another SIPP pension of £350,000 which I have not drawn down. If I do nothing, will I lose the chance to draw 25% (£87,500) of the pension tax free?

I know that if I die before I am 75 my family will be able to draw on the pension tax free. However, once I reach 75, they would have to pay tax at their marginal rate. 

Our estate will be valued at more than £1 million so it is important the remaining SIPP pension would not be part of our estate.

Brendan

Rachel Vahey, AJ Bell Head of Public Policy, says:

Under pension rules, someone’s 75th birthday has always been an important milestone. That was because it meant a further test against the lifetime allowance of any untouched pension funds, plus any investment growth in drawdown plans. That test has effectively been dropped for this tax year and will be gone completely from April.

But age 75 remains a key date. If someone dies before this birthday, then any lump sums paid out to their beneficiaries will normally be tax free up to a £1,073,100 limit, and any income paid out to them, say from their drawdown plan, will normally be completely tax free. If the pension saver died on or after this birthday, then any lump sums or income paid out would be subject to income tax.

Pension savers can usually take up to 25% of their pension fund as a tax-free lump sum. There is nothing stopping people from taking this lump sum after their 75th birthday. It should still be available (although you should check the pension scheme rules allow this).

PROS AND CONS

There are, as you have identified, pros and cons to taking the tax-free lump sum, where someone doesn’t need the funds.

If they keep it in the pension, then it can grow in a tax-efficient environment. It will also be shielded from inheritance tax.

The pension saver can identify who they want to benefit from the pension funds. And although it will be subject to income tax (if the pension saver dies after age 75), the beneficiary can decide how and when to take the funds.

For example, instead of passing the funds to a spouse who doesn’t need them, or an adult child, someone may want to leave it to a grandchild who isn’t currently paying income tax, or who is a low earner. They can then manage their withdrawals to keep down any additional tax bill.

It’s important if a pension saver wants to leave the funds to someone other than a dependant (usually their spouse or any of their children aged under 23), that they complete a nomination form making their preferences clear. And review this on a regular basis.

Taking the 25% lump sum means getting it tax free. But it will fall into the pension saver’s estate for inheritance tax purposes.

GIFTING CASH

The money can be gifted to others. Everyone is entitled to give away up to £3,000 a year as a gift free of inheritance tax. And there are other gifts which can be made on top of that – such as to help pay for a wedding.

Gifts can also be made tax-free as part of a normal pattern of expenditure, where they are paid from surplus income each year whilst the person retains sufficient income to maintain their normal standard of living.

And finally, a potentially exempt transfer - or PET – means if someone decided to make a gift above the £3,000 annual gift allowance then the funds would only become chargeable to inheritance tax if the person didn’t survive for seven years from the date of the gift. So, deciding whether to gift any pension tax-free lump sum may also depend on the pension saver’s health, if they want it to count as a PET.

Do you have a question on retirement issues?

Send an email to askrachel@ajbell.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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