Very often, an individual's second largest asset, behind their private residence, is their pension fund, yet it is often ignored when considering inheritance tax planning.
Recent legislation changes have put an end to the potential 82% tax charge that could arise on the death of an individual, who was aged over 75 and the remaining value of their pension fund was paid out to their dependants.
The tax charge has now been reduced to 55%, irrespective of age, where pension benefits have started to be withdrawn.
The value of the fund can be transferred to a surviving spouse, without a tax charge, but only within the existing pension structure. But on their subsequent demise, the 55% charge will then apply.
If someone were to die, before they had started to draw benefits from their fund, the whole of the fund can be paid out, completely free of tax, to their surviving spouse or nominated beneficiaries.
If it is paid out to the surviving spouse, the value of the assets will simply add to that person’s taxable estate for inheritance tax purposes. Rather than transferring the assets outright to the surviving spouse, consideration should be given to transferring the assets to a discretionary trust for the benefit of the spouse and other dependents, in order to protect those assets from future potential IHT charges.
The trust can make loans to the surviving spouse if required, so that he or she can still have access to the funds.
When someone is about to start drawing benefits from their pension fund they now have some tax planning options to consider. With the new flexible drawdown pension, they could draw out the whole of their fund (25% tax free and the balance subject to income tax at either 40% or 50%) but those net funds would then form part of their taxable estate for inheritance tax purposes.
Alternatively, they could draw a normal annual pension from their fund, in the knowledge that this will be liable to income tax, but that on the second death, the remaining assets will be subject to tax at 55%.
It is anticipated that many people will opt for the flexible drawdown option if they can.
