The pension landscape has changed dramatically following the changes to the rules on 6 April 2015. An element of freedom, a word not often associated with pension arrangements, has been granted by these changes. Pension owners now have real options as to how their pension benefits should be passed on following their death.
The changes mean that anyone who has a money purchase (commonly known as a defined contribution) pension can now pass the remaining value of their fund on death to anyone. This will be free of all tax if the individual dies before the age of 75, and on a more favourable basis if the individual dies after reaching that age. This is a significant improvement on the old regime, where passing on lump sum death benefits could attract a 55% charge and the list of individuals who could benefit from the pot was restricted to a narrow range of people, defined as ‘direct dependents’.
When it comes to thinking about estate planning for the benefit of those left behind, the pension landscape has been changed by the new rules. The tried and tested estate planning methods have been challenged and this has given pension holders a great deal to think about when considering how best to pass on the remainder of their pension pots.
Traditionally, owners of pensions would establish a spousal by-pass trust in their lifetimes. The beneficiaries of the trust would be the pension holder’s spouse and children. In order to prevent the value of the pension pot falling into the surviving spouse’s estate, the lump sum benefit would instead be received by the trust. The downside to this was that a tax charge of 55% was applied to the fund going into the trust if the death occurred after the age of 75.
The more flexible tax regime brought in by the changes on 6 April 2015 means that there is now a real case for leaving funds within the pension wrapper and not directing the funds into trust. Avoiding the use of a spousal by-pass trust may indeed lead to a more beneficial tax arrangement.
An additional advantage of the new pension rules is that the once restrictive class of persons able to benefit has been widened. Beneficiaries may now include nominees and successors. Nominees are chosen by the pension owner and are those people they wish to inherit their pension fund after their death. These will likely be a mixture of dependents and any other people that the holder decides upon. A successor is somebody chosen by the nominee to inherit their own benefit after their death. Interestingly, the owner of the pension pot will not, therefore, have direct control over who the successors are. This makes the choice of nominees important – sometimes a nominee will become unsuitable simply by virtue of the persons they might choose as their successors. The flexibility of the new arrangements is welcome, but it increases the importance of well thought out and appropriate nominees.
There are many who have described the pension fund in its new form as the most attractive option for individuals wanting to accumulate capital with the ability to pass it on to multiple generations with favourable tax treatment. There is some merit to this view. If the new nominations rules are used properly the pension fund will also be a good way of allowing wealth to skip generations and directly benefit children or their remoter issue.
The role of traditional spousal by-pass trusts in estate planning is now limited. However, it may be a more secure vehicle for preserving the value of the pension fund for the holder’s direct descendants after death. The use of trusts can limit the ability of a surviving spouse, or their potential new partner (or partners of the holder’s children) to reduce the funds by reckless spending.
And what about the circumstances where the numbers aren’t the most important thing? Estate planning is also about protecting wealth against the unforeseen developments in beneficiaries’ lives. Examples include bankruptcy, divorce and future care costs. These are threats to an individual’s estate against which a more traditional spousal by-pass trust may provide more protection.
In bankruptcy, creditors look to identify any potential assets of the bankrupt which they can get their hands on to satisfy the debt. Recent case law has suggested that, should a nominee of a pension pot become bankrupt, the value may be vulnerable to creditors. A spousal by-pass trust that removes death benefits from the nominee’s control and places them in the hands of the trustees will no doubt provide a higher degree of protection in the event that a nominee becomes bankrupt.
And what about the possibility of the divorce of a nominee? When a divorce settlement is reached, the assets of both parties are assessed and are available to be shared. It seems likely that benefits received by a nominee from a pension pot will be vulnerable during any divorce settlement. Again, a discretionary spousal by-pass trust ensures that the fund remains in the hands of the trustees and hopefully not taken into account in any divorce settlement.
Finally, and perhaps most significantly, the issue of future care costs needs to be considered. This is a topical issue and current rules ensure that an individuals assets must drop below a certain value before that person is eligible for assistance from the local authority for care fees. A pension fund nominee will not want the value of a pension pot from which they benefit being taken into account when eligibility is considered. Once again, the traditional discretionary spousal by-pass trust arrangement will prevent the pension fund from automatically being taken into account when the local authority calculates whether financial assistance for care costs is available.
In conclusion, while the tax treatment of the new pension regime may be more favourable, numbers alone are not always the most important thing. Properly constructed and considered trusts can be crucial to preserving wealth for future generations. It is also important to remember that the pension rules are consistently being changed. There is no guarantee that they won’t be reviewed again in future. In light of this, when considering estate planning after death, pension owners may be drawn to the more traditional tried and tested trust methods.
In an age where pension funds are frequently an individual’s most valuable asset, the need to take professional advice as to how pension benefits will pass after death is fundamental. Pension funds will likely have been saved over decades and are a direct result of the hard work of the pension owner throughout their lifetime. The question of how the most benefit may be extracted from them should be given an equal amount of care and attention.