Q. I am a widower with three children and two young grandchildren who will inherit my estate when I go. A large chunk of it is destined for the taxman so I am trying to be as efficient as possible in my planning. I am lucky enough not to have needed to touch my pension and intend to keep it that way. I understand that pensions can be passed on free of inheritance tax (IHT) but have read about beneficiaries still needing to pay income tax. I’m keen to understand exactly how this works and if I should leave my pension to my grandchildren who pay a lower tax rate?Adrian, Monmouth
You’re right that pensions can usually be passed on free of inheritance tax (IHT). Pension savers can nominate anyone to get the funds in their retirement pot on their death by filling in a nomination form. The pension scheme administrator or trustees must then consider these nominations, together with anyone who was financially dependent on the deceased.
Nominating beneficiaries would allow them to either take their share of the pot as a lump sum, or leave it invested in a pension (with tax advantages) and use it to provide an income as and when they need it. If you don’t make a nomination, your beneficiaries could be left with just a lump sum option.
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Inherited pension money can be accessed straight away — there’s no need to wait until the beneficiary hits the normal pension access age of 55 (57 from 2028). If young children (or grandchildren) are nominated and inherit the funds, their share could be kept in a pension under their legal guardian’s control until they turn 18.
Whether or not income tax is payable depends on your age when you die.
If you die before 75 There’s usually no income tax for those inheriting your pension, but there is a limit on the total tax-free lump sums that can be paid from your pensions both in your lifetime and to your beneficiaries after your death. This is set at £1,073,100 for most people. This limit would not apply if your beneficiaries use your pension funds to provide an income.
If you die after 75 Tax would be due on anything that your beneficiaries withdraw, and would be charged at their income tax rate. The tax they would pay depends on their other income and whether they choose a lump sum or to leave funds in a pension to provide an income.
Keeping the funds in a pension would mean that they have the flexibility to plan their withdrawals alongside their other taxable income. They wouldn’t have to take income at all if they don’t need it and could save withdrawals for years when they will have less income from elsewhere.
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Leaving pension funds to grandchildren could prove tax-efficient because they are likely to have their full tax-free personal allowance — currently £12,570 — available each year.
Much will depend on the value of your pension pot and the financial position of your beneficiaries.
If you are still some way off 75, you could consider nominating your three children to get the bulk of the pension pot, with your two grandchildren nominated for a small percentage, for example 2 per cent each. If any of your children decide they do not want their share, they can waive it and ask the scheme administrator to consider the grandchildren or their siblings for a greater share instead.
Once you turn 75, you could review your nomination and alter the percentages if you wish. The important thing is that the children and grandchildren are nominated, which gives them the flexibility of keeping the funds in a pension when you die.
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Whatever you decide, I’d recommend contacting your pension firm to check that they can carry out your wishes, including whether they will allow your beneficiaries (including grandchildren) to choose a pension option for any death benefits.
Although we have concentrated on your pension here, I’d also suggest getting formal advice on your will and estate planning. This will make sure that you are making the most of the IHT allowances and exemptions available.Charlene Young is a chartered financial planner. She joined AJ Bell in 2014 and is the company’s pensions and savings expert.