How Do I Start a New Personal Pension?
Question asked by Todd Green
I like the idea of being able to leave my unspent pension to my son and two daughters and my five grandchildren but I’m not sure what I need to do. How does this work in practice?
The pension freedoms that came into force in April of 2015 introduced a number of important new ways for savers to access their money purchase pension savings. Importantly, the new rules also abolished the previous 55% ‘death tax’ attached to pension savings.
Under the new regime, pension assets can now be passed to your beneficiaries free of inheritance tax and, for those who die before age 75, typically free of any income tax liability for the recipients. This is a major boon for those who have saved carefully over their working lives and want to be able to leave their pension wealth to their loved ones if they don’t spend it all before passing away.
Under the current rules, assuming you die before age 75, all your pension assets can usually be passed to your beneficiaries free of tax.
Your beneficiaries can choose to continue drawdown — a process called nominee drawdown — and enjoy the income tax-free or they can purchase an annuity, the income from which will also be free of tax. If you die after age 75, your beneficiaries will be liable to income tax at their marginal rate on anything you might leave them.
This will include tax on any income they might receive if they choose to continue with drawdown or on the income from any annuity they might purchase with the funds you pass to them.
The above rules assume you have a defined contribution (money purchase) pension. This is a pot of money you have been saving into throughout your working life with your name on it, so it’s yours (and potentially also belongs to your beneficiaries after you’re gone).
With a defined benefit pension, also referred to as final salary scheme arrangements, the pension is a promise from your employer to pay you an income for the rest of your life. There’s no pot of money backing this up, so it’s much harder to pass down the pension to future generations.
When you and your spouse die, the pension dies with you. This is regardless of how long you may have been receiving the benefits.
As such, a transfer from a final salary to a money purchase scheme enables you to take advantage of the new pension freedoms and to create a pension ‘pot’ that can not only provide you with a source of income in retirement but which can also be passed to your beneficiaries.
While a final salary pension transfer won’t be in the interests of most people, who will benefit from a guaranteed, inflation-proof income for life from the scheme, for a minority of people a transfer may make sense, with the desire to leave a pension to loved ones potentially being among the reasons to transfer.
This is especially the case if you’re seriously or terminally ill and will likely only be drawing your final salary pension for a limited time as a result, meaning you’d potentially see more benefit from a transfer.