Pension death benefits do not form part of your estate for inheritance tax purposes, and are not distributed under the terms of your will or intestacy. When you commence a pension you will nominate a beneficiary or beneficiaries, whom you wish to benefit in the event of your death beyond retirement.
Tax Status of Pension Death Benefits.
If you die before retirement, the funds are paid to your beneficiaries free of inheritance tax. However, if you die after commencing benefits or after age 75, there will be a tax of 55%, unless your spouse or a dependent child continues the pension.
Benefits are paid to individuals free of inheritance tax; they then form part of the beneficiary or beneficiaries’ estate. A financially advisable tactic might be to pay the benefits to your children rather than your spouse (although your spouse would have no access to the funds).
Paying benefits to a trust
Another advisable strategy is to set up a trust to receive your pension benefits in the event of death before retirement. The benefit of the trust is that it protects against hostile creditors, for example bankruptcy, care fees and divorce. It is destined to reach your children, beyond the life of your surviving spouse, rather than a future spouse. It also preserves the inheritance tax benefits for another generation.
Control over who receives the benefits
You may not want your spouse to receive the entire fund, remarry and then potentially pass to a new spouse, die before that new spouse and then the benefits end up with a completely different family. However, you may not simply want to nominate all family members at death. Trustees can make decisions based on circumstances at the time of payment instead.
You may be worried about your spouse remarrying, that marriage breaking down, and the impact on your children and their financial future. Legislation states that there can’t be a pension sharing order on dependants’, nominees’ or successors’ drawdown. However, it still might be a matrimonial asset on divorce.
Control over the way benefits are taken
Perhaps you do not want your children having access to a large amount of money. A trust means that access to funds can be restricted and avoids the situation of an 18 year old taking a large fund in cash.