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A recent pension law upgrade could be a game-changer in terms of advising clients on how their wealth is transferred. By Julie Hutchison
The alterations to pension law that came into effect on 6 April have changed the game when it comes to estate planning advice for clients. Pension wealth can now be inherited more easily.
Lawyers will need to become familiar with options for the payment of pension death benefits to ensure estate planning advice is accurate. With pension pots of £1.5m or more, many high-net-worth clients will need advice on how best to structure the way wealth is inherited.
Prior to 6 April, when a client died after the age of 75 the death benefit could be subject to a tax charge of 82 per cent. This led many providers to only offer a charitable lump sum death benefit (LSDB).
The rules open up LSDB options for the over-75s. Funds can be distributed with a 55 per cent tax charge on death. Mortality tables suggest that a male going into drawdown - ie taking an income - at 55 is likely to survive beyond his 80th birthday.
This means that for most individuals in drawdown the new rules are much more favourable. Funds that may previously have been paid to charity will now be available to family members. This opens up the estate planning options for pensions.
For clients who die before 75 and were in drawdown, the 55 per cent charge also applies. This is less favourable as it is an increase from 35 per cent under the old rules. However, for clients who die before 75 and have not touched their pension pot there is no tax charge.
Where there is a surviving spouse there is still a decision to be made as to whether to take a LSDB or to continue in drawdown. Taking a spouse’s drawdown will delay any 55 per cent charge until the surviving spouse also dies.
There are other considerations that might influence decision-making. Where a widow(er) has taken drawdown the final destination of the residual death benefits for the spouse’s drawdown fund will rest with the widow(er). This may be a concern for the original spouse, particularly where there are children from previous marriages.
And what if the surviving spouse loses capacity and does not have a suitable power of attorney in place? Or what if they meet a new partner and decide to leave everything to them? Is this what the first spouse would have wanted?
Where the LSDB is paid to a discretionary trust on the first spouse’s death, none of these negative outcomes arise as the trustees are in control of the funds. A discretionary trust is typically set up during an individual’s lifetime to receive any future LSDB. It is, of course, a vital step to check that the pension scheme rules allow payment of an LSDB to a trust.
Using a discretionary trust is an effective way of controlling who will benefit from any LSDB. Asset protection, flexibility and inheritance tax outcomes are all possible benefits, as well as an element of ’control beyond the grave’.
If the surviving spouse opts for a lump sum, it may well remain in the widow(er)’s estate. As a result, on their death it could be subject to 40 per cent inheritance tax depending on the available nil-rate band. This does not happen where funds are retained in discretionary trusts.
Trustees may be able to make loans to a beneficiary that lawyers can document. The benefit here is that the loan could be a deduction from the beneficiary’s estate. Care is needed where the surviving spouse has made third-party contributions to the deceased’s pension. It is possible that in such cases loans would not be deductible for inheritance tax.
Where a large sum is held in the ongoing discretionary trust a question will arise about the 10-year charge for inheritance tax. It is possible that what appears to be one trust is in fact several settlements for inheritance tax, in view of the history of the client’s pension savings over their lifetime.
Circulars from the Association of British Insurers and HMRC shed light on client scenarios. It is enough to be aware that there can be advantages in tracing the client’s pension consolidations and transfers over the years, since the pension they held at death may in fact represent various historic pensions. This could affect the inheritance tax treatment of the discretionary trust. The good news is that, where a variety of pensions sit behind the final pension at death, it may be that 10-year anniversary charges are eliminated.
In summary, the use of a discretionary trust could provide many long-term benefits for clients and their families in terms
of controlling how pension wealth is transferred. Lawyers will need to become familiar with how a variety of pension schemes operate and it may be necessary to review clients’ files in light of the new rules.
Julie Hutchison is head of estate planning at Standard Life