When planning your estate, it’s easy to overlook the allocation of specific assets and assume they will automatically be distributed in line with your overall wishes.
However, without careful consideration, some of them may not be allocated as you intend.
Pensions are particularly important to designate. If you haven’t specified your wishes or updated your beneficiaries, the pension trustees may make a decision that doesn’t align with your wishes.
Moreover, pensions are usually excluded from your estate and are not subject to Inheritance Tax (IHT), making them a more tax-efficient asset to pass on compared with other holdings.
Even if you do nominate your desired pension beneficiaries, without adequate financial planning, they could miss out on the tax advantages of an inherited pension and could pay up to 45% in Income Tax or 40% in IHT.
So, designating and updating your pension beneficiaries both ensures your chosen heirs receive your pension and that they get the maximum benefit from your legacy with minimal tax liabilities.
Read on to find out how to make sure the wrong person doesn’t inherit your pension.
More than three-quarters of a million people risk leaving their pension to the wrong person
A study reported by FTAdviser found that more than three-quarters of a million (773,000) people aged between 55 and 64 are at risk of leaving their pension to the wrong person when they die.
This problem usually occurs if you have instructed your pension scheme to leave payments to a first spouse but later divorce, remarry, or enter a new partnership. If you don’t update the paperwork, there’s a risk that any benefits after your death could still go to your ex-partner instead of your current one.
This highlights the importance of nominating and regularly updating your pension beneficiaries.
By doing so, you ensure your pension provider and scheme trustees know exactly who you wish to inherit your pension when you pass away.
Typically, your provider will ask you to complete an expression of wishes form, clearly outlining your chosen beneficiaries.
You can update these nominations at any time, and it’s a good idea to review them after significant life events – such as the birth of a child or grandchild, marriage, divorce, or the death of a loved one – to ensure your wishes remain aligned with your circumstances.
Nominating pension beneficiaries could also enhance the tax efficiency of your legacy
Nominating pension beneficiaries not only ensures your pension is passed on to the right individuals, but it can also enhance the tax efficiency of your estate, helping to preserve more of your wealth for your loved ones.
For instance, you can lower the overall tax burden on your estate by designating your pension to a beneficiary with a lower income while assigning other IHT-liable assets to someone with a higher income, as inherited pensions are typically taxed at the recipient’s marginal rate.
Moreover, if you have multiple beneficiaries, you can specify how you would like your pension to be divided.
For example, if you have two beneficiaries with different earnings, you might choose to allocate a quarter of your pension to the one with a higher salary, while granting the other three-quarters.
This could help ensure that neither is likely to be pushed into a higher Income Tax bracket when they make withdrawals.
So, with careful planning, allocating your beneficiaries could mean that you mitigate the total tax charged on your estate.
How your pension is taxed after your death depends on several factors
When you pass away, how your pension is taxed depends on:
- The type of pension you hold
- Your age at death
- How much you have already withdrawn
- How your beneficiaries make their withdrawals.
Generally, HMRC excludes pensions from your estate, meaning they are typically not subject to IHT. However, if you withdraw funds from your pension wrapper before your death, those amounts may be liable for the 40% IHT rate.
So, it can be wise to plan carefully and keep the funds within the pension wrapper to maintain tax efficiency and minimise potential tax liabilities for your beneficiaries.
Moreover, if you pass away before the age of 75 and have not accessed your pension, your beneficiaries will receive the pension tax-free, up to the lump sum and death benefit allowance (LSDBA) of £1,073,100 for the 2024/25 tax year.
Any payments over the LSDBA are normally taxed at your beneficiaries’ marginal rate of Income Tax.
If you die after the age of 75, your beneficiaries will usually pay Income Tax at their marginal rate on any pension you leave behind.
So, depending on how your beneficiaries choose to access the remaining pension, they could face up to 45% Income Tax on their withdrawals, which could significantly diminish the value of their inheritance.
To mitigate this, it may be beneficial for them to strategically plan their withdrawals to minimise tax liabilities and maximise the funds they inherit.
A financial planner can help ensure the right people inherit your pension and that it remains tax-efficient after your death
A financial planner can guide you through the process of nominating beneficiaries and can also provide valuable advice on how to divide your pension to ensure the tax efficiency of your legacy.
Additionally, after your beneficiaries inherit your pension, a financial planner can continue to work with them to optimise their withdrawals.
By navigating the complexities of tax regulations and strategically allocating beneficiaries, a financial planner can help ensure that the right individuals inherit your pension and maximise the wealth you leave them.
To speak to a financial planner, get in touch.
Email hello@solusfinancial.co.uk or call us on 01245 984546.
Approved by Best Practice IFA Group Limited on 18/10/2024.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
Taxation is dependent on individual circumstances and may be subject to change in the future.