Recent reforms have thrust pensions into the spotlight like never before, but evidence suggests the public still have relatively limited understanding of the key characteristics of pensions as a savings vehicle. Even fewer will be aware of the technicalities of pension legislation.
Amendments to the detail of the draft Taxation of Pensions Bill mean many risk blindly wandering into an unintended tax bill if they do not have a full understanding the tax rules surrounding pension death benefits.
Under today’s rules, scheme administrators are awarded some discretion over how dependants drawdown is paid out. Where the nominee is outdated, has never been specified or the nominee would prefer the pension pot to be passed on to someone else, the scheme can apply common sense.
This allows pension savings to be passed on – either as a cash lump sum or a dependants pension – in a manner which best suits the personal circumstances of the beneficiaries.
However, new rules indicate schemes will not be given that discretion where an individual is taking benefits under the new flexi-access drawdown system. Dependants benefits must instead be paid out to the most immediate dependent or the nominee, where one has been designated by the member.
In most cases, passing benefits on to a spouse will be the preferred option anyway and defaulting to this will not be a problem.
But for others, it could mean an unnecessary tax bill.
Take a married individual that dies at, say, 73. Following the abolition of the 55 per cent death tax on pensions, that money could pass on totally tax-free to any beneficiary. Assuming the individual’s partner is comfortable in their own retirement, it may well be preferable to pass the assets within the pension wrapper to children (or even grandchildren) to draw as income as they wish without paying any tax.
However, the current Tax Bill proposals stipulate the scheme must pass the benefits on to a spouse or children under 23 unless the member made a specific nomination before death. The worst-case scenario would see the pension paid by default to a spouse with no need for the additional funds.
If they then subsequently die aged over 75, when the pension pot is eventually passed on it will be taxed at the beneficiaries’ marginal rate. That tax could easily have been avoided by nominating the children as original beneficiary.
We regularly encounter similar cases but are able to exercise discretion. This option will not be available in future and it seems inevitable some customers will fail to make nominations, despite prompts from their provider.
This is a perfect example of a scenario in which taking advice helps customers ensure they have total peace of mind, knowing they have taken all the necessary steps to pass their savings on to loved ones without unwelcome cost.
Jon Greer is pensions technical manager at Old Mutual Wealth