Money Mailbag: Can I leave my pension to my grandchildren?
Thanks to new pension rules, the easy answer to your question is yes – provided you’re in the right type of scheme at retirement.
Previously, if you were a member of a pension scheme you could only provide a ‘secondary pension’ to a ‘dependant’. This could be a spouse, civil partner, a child under the age of 23, a child over 23 but still financially dependent, or any other person financially dependent on you, such as a partner or an ex-spouse.
Grandchildren would therefore not qualify under normal circumstances. But this has all changed with Chancellor George Osborne’s pension freedom rules, which allow anyone 55 or over to access their entire pension pot.
“If you are in a personal pension or a self invested personal pension (SIPP) at retirement then under the new pension freedom rules, which came into effect in April this year, you can now pass on both lump sum death benefits and pensions to anyone as long as you notify the scheme administrator,” says Steve Patterson, managing director of Intelligent Pensions.
“However, if you buy an annuity when you retire or you’re in an occupational pension then normally you can still only provide a secondary pension on death for qualifying dependants. This is one of the reasons ‘pension drawdown’ is growing in popularity and we are seeing people moving away from annuities.”
Under pension drawdown you can leave the pension fund money to anyone, either as a lump sum, or as ongoing pension pots, or a combination of the two. On death before age 75 all benefits are free of tax, whether taken as a lump sum or as pension drawdown. On death after 75, a lump sum under the current rules would be subject to a 45% tax charge, while a beneficiary taking pension drawdown from their inherited pension pot will only pay tax on the income withdrawals they make at their own marginal rate of tax.
“One of the advantages of not taking the lump sum is that the person you leave it to can enjoy the ongoing tax advantages of holding the money in a pension fund, which grows tax free. Also, if any of the fund is taken as a lump sum this immediately falls into the beneficiary’s own estate for inheritance tax, but if it stays in the pension fund it can potentially be passed down to the next generation without inheritance tax,” says Patterson.
“You don’t have to take any income from a beneficiary’s drawdown fund, so if you leave money to someone, they can leave it within the pension to continue to grow alongside their own pension to enhance their income in retirement.
“If an income is required earlier, the beneficiary can draw down as much or as little as they need from one year to another, regardless of their age. If the beneficiary is a minor, then it’s the beneficiary’s parent or legal guardian who would decide whether an income should be taken and, if so, how much. This might be needed, for example, to fund school fees. As minors have their own personal allowance for income tax, up to £10,600 can be drawn down tax free each year.”
Putting your wishes in writing is essential, otherwise it’s highly likely the administrator will simply pay the fund out to your estate, where it would be counted for inheritance tax purposes.
Patterson adds: “Pension schemes normally have a death benefit nomination form for this purpose. However, if you have a larger fund, you should ask your solicitor to provide a more specific wording in the form of a ‘letter of wishes’, which is like a ‘pensions will’. Due to the complex tax position this should always be done in conjunction with a pension drawdown expert, as most solicitors are unfamiliar with the new pension rules.
“Some schemes won’t accept anything other than their own standard nomination form, but this can lead to problems. Ideally, you want to make sure that your spouse or civil partner is looked after first, and consider what you want to happen to the remaining fund on their death if you’re the first to pass away. You might also want to provide for certain contingencies. For example, what should happen to a beneficiary’s share if they had already passed away, would you want their share to be split equally among the other beneficiaries, or (where the initial beneficiary is your son or daughter) that their share should pass over to their children instead.”
If you have a question for our experts, please email the editor Joanna Faith.