With mandatory retirement at age 65 abolished and the state pension age due to increase to age 67 from 2028, the Beatles’ famous song about being ‘over the hill’ at 64 years of age seems increasingly out of touch.
For those of you with a personal pension fund (as opposed to a final salary pension) the time when you have to make some key decisions is even later, at age 75.
This is the first of two articles explaining the importance of your 75th birthday for pension planning purposes. This article looks at what your nominated beneficiary(s) might inherit from your pension if you die either before or after age 75. The second article, which will be published in the November newsletter, will look at the interaction between the lifetime allowance tax charge and your 75th birthday.
What might your nominated beneficiary(s) inherit from your pension if you die before age 75?
If you die before reaching age 75 your nominated beneficiary(s) will receive your pension fund entirely free of either inheritance tax or income tax. This means that they will be able to draw out all of the money held in your pension without paying any tax at all (so long as no lifetime allowance charge is payable, which will be the subject of an article in the November newsletter).
As a consequence, somewhat surprisingly, your beneficiaries would stand to benefit from a preferential tax position to your own if you remained alive: if you draw money out of your own pension only the first 25% of your pension fund can be withdrawn tax free, with the 75% balance taxed at your marginal rate of income tax.
How might this change if you die after age 75?
If you die after your 75th birthday, your nominated beneficiary(s) will still receive your pension fund free of inheritance tax. But they will unfortunately have to pay income tax at their own marginal income tax rate on any money that they withdraw from the pension. If you had not drawn all of your 25% tax free allowance out of your pension before you died, this would also be lost to your beneficiaries.
Is there any action you should take leading up to your 75th birthday?
You should think about whether it is appropriate to withdraw any unused tax free cash allowance prior to your 75th birthday. Whether drawing out the tax free cash makes sense will depend on your overall inheritance tax position. Given that any money held in your pension on death will not suffer inheritance tax, you need to be aware that any tax free cash you draw out of your pension may suffer 40% inheritance tax if it hasn’t been spent or gifted away by the time of the death of the last of you/your spouse. By contrast, a beneficiary of your pension may be able to draw the money out at a 20% rate of income tax.
This is a complicated area with different moving parts and the ‘correct answer’ will vary depending on individual circumstances. Do seek advice as you approach (or ideally well in advance of approaching) age 75 to make sure that you pursue the most appropriate strategy.