In our weekly series, readers can email in with any question about retirement and pension saving to be answered by our expert, Tom Selby, director of public policy at investment platform AJ Bell. There is nothing he doesn’t know about pensions. If you have a question for him, email us at money@inews.co.uk.
Question: I’m currently 70 years old and intend to leave whatever is left in my Self Invested Personal Pension (SIPP) to my granddaughter who is 17 years old. What are the current regulations regarding at what age she would be allowed to access the money, and is there any method to ensure it stays invested until she is of pensionable age?
Answer: Savers have a lot of flexibility when deciding who to leave their retirement pot to. The tax treatment of pensions is also extremely generous, with money inherited usually free of inheritance tax (IHT).
In fact, it is possible to pass on your pension pot completely tax free to your nominated beneficiaries if you die before age 75. If you die after age 75, money inherited will be taxed in the same way as income.
But as with many elements of pensions, the rules can sometimes be quite complicated. Pension money is usually held within something known as a “discretionary trust”. This means the trustees or scheme administrator are responsible for the money and must make decisions in the best interests of the pension scheme members.
The final decision regarding who receives the pension pot when a member dies rests with the trustees or scheme administrator. However, you can make your wishes known and nominate anyone you want to have the pension funds when you die.
When paying out the money on death, the trustees want to make sure any dependants of the individual are financially looked after. Usually, they would be inclined to pay out to a spouse or partner living with the person. In most circumstances, this matches the nominations people make.
You can, however, nominate someone else to inherit the funds, for example children or grandchildren. The trustees or scheme administrator would then consider that person. If you still have a dependant living, then the trustees or scheme administrator will want to make sure that person will have enough money from other sources to live on. It’s important in this situation to give the trustees or pension scheme sufficient information to help them make this decision.
When someone inherits the pension fund from a SIPP, they may be able to access the funds by taking a lump sum, buying an annuity to give themselves a guaranteed income for life, or moving the money into drawdown (where your money is invested and you take an income to suit your needs).
A nominee or dependant inheriting pension money gets the money straight away – they do not have to wait to reach age 55 or 57. However, if younger children inherit the funds, they could be kept in a pension with their legal guardian controlling investments and withdrawals until they turn 18.
You could consider setting up a “bypass” trust to add some rules or control over who inherits the pension money, how they can take it and when. Here’s how it works.
Making a nomination
The pension holder nominates the trust to receive their pension as a lump sum payment on their death. They choose the trustees and can give them clear instructions which are more nuanced than pensions allow. For example, they could say pay out an income rather than a lump sum, or put a minimum age for the beneficiary to access the pot.
If the person dies after age 75 there will be a 45 per cent tax charge when the pension pot is paid to a bypass trust, although the beneficiary may be able to claim some or all of this back when they receive income from the trust.
Before age 75 it will be tax free if the pension saver has enough remaining “lump sum and death benefit allowance” and the money is paid within two years of the pension scheme being told about the pension saver’s death.
The lump sum and death benefit allowance is the maximum that can be passed on as a tax-free lump sum to your beneficiaries before age 75 and is currently set at £1,073,100 for most people. Any tax-free lump sums the member has taken in their lifetime will reduce the available allowance on their death. There is no limit if the pension is used to purchase an annuity or provide drawdown income.
When the benefits are paid out, they will be added to the beneficiary’s income for tax purposes. If 45 per cent tax was deducted when the pension pot was paid to the trust this can be used to offset any income tax due.
There may be IHT charges on every 10-year anniversary of the trust (the periodic charge) or whenever property leaves the trust (the exit charge). The working out of these taxes can be very complex and there are other tax considerations to bear in mind as well.
It’s for these reasons, individuals considering a bypass trust need to take care. Although they can exert extra control, that comes with additional costs and taxes. Anyone thinking about this should seek specialist advice.