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Many of us want to leave a legacy to our loved ones and there are several ways, such as saving and using Trusts, of facilitating this. But have you asked yourself “What happens to my Drawdown Pension if I die?” If you opt to take your retirement income as drawdown instead of buying an annuity, one of the benefits is that you can leave what is left in that pension when you die to your chosen beneficiaries. Once upon a time there was as high as 82% tax on this pot of money; a level of taxation that would have made Dick Turpin blush! However, all of this has changed dramatically for the better, so let’s look at the detail.
After we left the 82% tax world, we entered an environment where your pension pot was taxed at 55% on death if you were in drawdown, but this 55% death tax was scrapped at the end of 2014. It was replaced with a more complicated but for lenient tax system. Yes, you heard me correctly, a more lenient death benefit on your pension!
What Happens to My Drawdown Pension if I Die Before Age 75?
If you are in Pension Drawdown, i.e. you have taken some or all of your tax free lump sum, may or not be taking an income, and you die before the age of 75, you can leave your pension to your nominated beneficiaries free of any Inheritance Tax. Let me repeat that, because it’s quite important. If you die before the age of 75, you can leave your pension to your nominated beneficiaries free of any Inheritance Tax. This could be your spouse, your children, or anyone in fact, as long as you have declared who this person will be on your ‘Nomination of Beneficiaries Form’.
What Happens to My Drawdown Pension if I Die After age 75? Now it gets a little more complicated. If you die after you reach age 75, this money can pass to your nominated beneficiaries, however it will be taxed according to their own Income Tax rate at the time when they draw the money out. For example, if they are already a 40% tax payer, they can draw the money out at 40%, however care is needed in how they do this to avoid paying more tax than necessary. For example, if it was sufficient to take their earnings to more than £100,000, they would effectively lose 60% tax between £100,000 and £120,000, because they would lose their personal allowance. Again, for a larger pension this may take them into the 45% tax bracket.
Even if it does, comparatively speaking this is dramatically less than the tax would have once been. However, drawing the money out more gradually, or waiting until lower earning years, presents an opportunity to pay less tax still.
What if your grandchildren were the beneficiaries instead of your children? Now this presents an interesting opportunity. They are likely to be zero or at worst 20% tax payers, so leaving the pension directly to them would allow them to take it out with much less tax. Could it be in years to come we are seeing the children pay for their own education and for the family holiday from inherited pensions? It certainly seems like that could be an interesting way of extracting the money even more tax efficiently!
So How Tax Efficient is a Pension Now? When it comes to Inheritance Tax planning, pensions are extremely tax efficient. You may want to consider spending everything but your pension first, and preserving that until last, as that way you will be reducing the assets liable to Inheritance Tax, and preserving the ones that are unaffected by it for as long as possible.
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