We are great fans of pension plans here at Rutherford Hughes. For those working for employers who provide defined benefit/final salary schemes' they can look forward to a guaranteed income in retirement. However' this article is not really aimed at them.
For the majority who do not have these guarantees’ their route is a defined contribution/money purchase arrangement. Here you build up the biggest pot you can to draw on in retirement’ as needed’ or to purchase an annuity.
Let me explain the attractions of the pension fund. Firstly’ you and your employer (which may be your own company) can offset contributions against Income Tax or Corporation Tax. The investment then builds up in a tax advantaged environment with no Income Tax or Capital Gains Tax to pay in the fund. The value of the fund is also outside of the estate for Inheritance Tax purposes when the owner dies. A tax-free lump sum can be paid out anytime after age 55′ even if you are still working’ which is typically 25% of the pot. A taxable income can also be drawn from this age’ again even if you are still working.
The attractions are the tax breaks and the flexibility on offer. However’ for anyone with a pension pot in later life’ age 75 is pivotal for them. It is so important that advice needs to be taken years in advance of reaching this age. So’ what happens at 75?
The first is that there is a Lifetime Allowance (LTA) test. This is a review of the values of your pensions’ whether taken or not’ and checked against the maximum you are allowed before an additional tax charge is levied.
The next issue is that the tax position on death benefits changes. Pre age 75 the whole fund is available to the beneficiaries of the pension fund tax free and can be taken as a lump sum or drawn over time. After 75 any pay-out is taxable in the hands of the recipient.
This leads on to an important point. Many pension death benefits are paid to a discretionary trust whereby the pension member can endeavour to hold some control beyond the grave. For example’ a letter of wishes to the trustee may state that the surviving spouse should receive a level of income but when they die the remaining funds should be distributed to “my” children. This is particularly relevant if there is a second marriage’ and the spouse has children of their own from a previous marriage.
The problem is that such trusts are taxed very heavily and suffer income tax at 45%. So’ from age 75 almost half the fund would go directly to HMRC! This leaves a lot less for the beneficiaries. It may also be that whatever issues the trust was supposed to cover have settled themselves. Clearly it is essential to review the ongoing need. Issues that need to be checked well before reaching age 75 are as follows: Do the existing plans allow benefits to be taken flexibly? Can they allow you to take your tax-free cash after age 75? Is a trust still appropriate? Are the funds invested appropriately for the client’s objectives? What are the death benefits on the old plans (often restricted’ sometimes just return of premiums paid)? Do several pensions need to be brought together which may save money? This last point needs to be treated with care. If the individual transferring the pension is in poor health and does not survive two years’ HMRC may take a proportion of the transferred funds to be part of deceased’s estate for Inheritance Tax purposes. Bottom line: seek advice well in advance of reaching milestone ages and make sure it is reviewed regularly.
