It’s possible to leave your retirement savings to someone in your will, although you should take time to research the options, as some are better than others and the rules are changing.
Here we look at the issue of inheriting, starting with capital held in personal and workplace pensions.
Inheriting an unused pension pot
Since pensions are invariably held outside the holder’s estate, they are not subject to inheritance tax. Moreover, an imminent change in the law will make it easier to leave any pension savings to loved ones, including children and grandchildren.
From April 2015, individuals with a defined-contribution workplace or personal pension who die before the age of 75 will be able to pass on their unused pension fund tax-free to any nominated beneficiary. Prior to this rule change, beneficiaries would have been subject to a 55% tax charge, dubbed the ‘death tax’.
If an individual dies after age 75, they will still be able to pass on their pension to a spouse, partner or other beneficiary. However, the recipient will pay income tax on the amount they receive at their marginal rate, so 20% if they are a basic rate taxpayer or 40% if they are in the higher tax bracket and 45% for top rate taxpayers.
Beneficiaries will also have the option of receiving the whole pension as a lump sum, subject to a tax charge of 45% if the deceased was over 75 (changing to the recipient’s marginal rate from April 2016) or tax-free if the deceased was younger.
Read about the new pension freedoms.
Traditionally, annuities have been a popular choice for pension savers on reaching retirement, as they provide a regular, lifelong income.
It’s possible to buy a joint-life annuity that will ensure a surviving spouse or civil partner receives payments after your death. You can choose whether you want the income payments to remain the same over the entire lifetime of the annuity, or whether you want to opt for a reduction – for example 75% or 50% – after your death. The latter options will be cheaper to buy.
With a single-life annuity, payments would stop if you die, unless there is a guarantee in place. For example, some annuities offer a guarantee payment period, usually lasting between one and 10 years. If you die during this time, your income payments will be paid instead to your spouse, partner or other beneficiary.
From April 2015, beneficiaries of individuals who die before the age of 75 with either a joint-life or guaranteed-term annuity will be able to receive any future payments from such policies tax free. For those who die after turning 75, the pension will remain taxable at the heir’s marginal rate of income tax. This rule change effectively brings most annuities into line with income drawdown.
The rules are also changing to allow joint-life annuities to be passed on to any chosen beneficiary, again from April 2015. Currently, you can only nominate your spouse, civil partner or a dependent as the person who receives an income from your annuity after you die.
Inheritance and income drawdown
Income drawdown has traditionally been the main alternative to buying an annuity. It allows you to draw an income directly from your pension pot. The amount will vary depending on how your investment performs.
If you die, your beneficiaries have three main options. They can continue to take your remaining fund as income drawdown, opt for a lump sum or simply convert the fund to an annuity, as you would with any other pension fund.
Prior to April 2015, beneficiaries choosing to take a lump-sum payment would have been subject to the 55% tax charge. From April 2015, they will receive this tax free if the person died before the age of 75, or taxed at their marginal rate if the person died on or after age 75.
For those continuing with income drawdown, income will paid tax free if the person died before age 75 or will be taxed at their marginal rate if the person died aged 75 or over.
If your spouse or any other beneficiary opted to use your remaining fund to buy an annuity, any income received from it would be taxable at the recipient’s marginal rate – regardless of the age at which you died.
Unsure about pensions? Read our jargon buster and guide to the pension rule changes.