How pensions and estate planning work together.

The Taxation of Pensions Act 2014 has created new opportunities for estate planning. It is now possible to leave money to beneficiaries other than a spouse or children (dependants), namely nominees, and on the death of a nominee or a dependant a successor can be chosen. In this way money can pass down through the generations and avoid inheritance tax. Where a client is worried about exceeding their nil rate bands on death there is clearly an opportunity to take some or all of retirement income from non-pension assets and leave pensions as a tax-efficient investment for grandchildren.

> Jack is married to Marilyn and they jointly own a large house in Guildford worth £900,000. Jack also has an investment portfolio worth £700,000, an ISA portfolio worth £100,000 and a SIPP containing collective investments worth £800,000
> Jack has now decided to start phasing his retirement at the age of 66 and is considering his options
> His original plan was to take his State Pension and crystallise his SIPP, using the tax free cash to pay off his residual mortgage of £100,000 and use the balance for the holiday of a lifetime and an emergency fund
> With assets totalling over £2.5 million he has a significant IHT bill to consider on the second death of either himself or Marilyn

As part of his IHT mitigation exercise we explain to him that by living off his part-time earnings and the State Pension, the current income shortfall can be met by drawing funds from his ISA or collective portfolios rather than crystallising his pension. If Jack dies prior to age 75 then his SIPP funds, either crystallised or uncrystallised, can pass directly to his nominated beneficiary who is his son David, totally free of tax.
 
If Jack is over 75 when he dies then David’s income will likely be taxed at 20% if he remains a basic rate tax payer and Jack has since entered flexi-access drawdown.
 
If Jack takes his income from his SIPP and leaves his ISA and collective portfolios intact then these would form part of his estate on second death and there would be significant IHT to pay at 40% of £2million, say £800,000 paid by his or her personal representatives.
 
If Jack wants to pay off his £100,000 mortgage now we would recommend he takes this from his ISA portfolio and leave the SIPP uncrystallised. Similarly his non-pension investments can be used to fund the holiday.
 
Clearly the income and Capital Gains Tax implications need to be taken into account as well and any funds taken from the collective portfolio may be subject to CGT. However from an IHT perspective this is an excellent recommendation and can be used as part of a solution including other IHT mitigation schemes.