Intergenerational planning – making the most of the new pension rules - Blog No.5

Your pension funds – their education, their first home

In this series of blogs, we’ve been making the case for passing funds to beneficiaries via pension arrangements, as it allows the funds to be passed down the generations tax efficiently.

In particular, we have focused on how pension funds inherited in this way are tax-free at the point of inheritance, although when the beneficiary subsequently takes money from the fund – if the original pension holder died over the age of 75 – he or she will be taxed at his or her marginal rate (of 0%, 20%, 40% or 45%). The beneficiary can access the fund at any time, at any age (legal guardians will act for minors), and withdraw any amount.

“The grandchildren have university years ahead of them. Now they are able to drip money out of their pensions to fund these. And because they have very little earnings during this period, if any, they can extract the money without paying any tax on it.”

What this means is that with careful management the beneficiary can control how much tax they pay on the inherited fund each year, taking care that the amount they withdraw does not inflate their annual income beyond their desired marginal tax band.

It is perhaps easiest to fully understand the advantages by looking at an example:

Say you have secured 40%, 45% or even 50% tax relief on contributions paid to a pension arrangement. Over the years it has grown in a tax-favoured fund, from which you have withdrawn 25% tax-free.

After death, even though you died after the age of 75, your remaining pension funds pass to your grandchildren tax-free because you directed them to be paid via pensions in their names.

The grandchildren have university years ahead of them. Now they are able to drip money out of their pensions to fund these. And because they have very little earnings during this period, if any, they can extract some money without paying any tax on it.

After university there are still funds left in the grandchildren’s pensions. This time they can drip cash though, over a period of years, to help build a fund to provide a deposit for their own property. The income they withdraw for this purpose might suffer just 20% income tax since they are in their first jobs and therefore earning only modest salaries.

So you can see, a pension has been an extremely tax-efficient vehicle by which to pass money down through the generations; certainly hugely more efficient than passing funds through your Will, which would automatically attract inheritance tax at 40%

Richard is a Chartered financial planner, Certified financial planner, Fellow of the Personal Finance Society, Fellow of the Institute of Financial Planning, and Affiliate of the Society of Trust and Estate Planning. He works with clients in Scotland and in London and has particular expertise in helping individuals and families pass wealth down the generations. View Richard’s profile here.

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