Four years ago, a major change happened in the world of pensions.
Flexi-access drawdown became a new tool we can use to help with a client’s retirement and the passing down of valuable estates to the next generation – all free of inheritance tax.
This blog will only refer to personal pension schemes as they tend to be the most common types of pensions amongst our clients. By helping you understand how flexi-access pensions work, this article should help you take your first step in planning your pensions with a good Independent Financial Adviser.
Pensions before flexi-access – a tax problem
Previously (before 2017), most pensions paid out a lump sum tax-free to the beneficiaries upon the pension holder’s death.
Any client who died before starting to draw the benefits was in a position where the pension funds were paid out tax-free. However, these funds then went to the estate of the beneficiary, which caused a problem.
The funds went from being inheritance tax-free into an estate where they were subject to inheritance tax, which meant the beneficiary had to pay out quite a large tax bill.
Here is a quick example:
Let’s say someone had a million-pound pension that was inheritance tax-free. When they died, that money was paid to their spouse or partner and it then went into his or her estate where it was subject to 40% tax, assuming he or she was already using their nil rate bands.
Flexi-access – freedom from heavy taxes
However, when flexi-access drawdown was introduced, that money could stay in a pension, in the hands of the beneficiaries, and be outside of their estate at the same time!
This is quite a complicated process, so the paperwork on the nomination form is critical. If it’s not completed correctly, the pension has to be paid out into the estate, and you are back in the world of 40% taxes (roughly).
Let me give you an example of how a flexi-access pension works:
Let’s assume that there is a family of four: a husband, wife and two children. If the correct nomination form is completed, then when the pension holder passes away, the money passes to the spouse as a pension rather than being paid into his or her estate.
The spouse still has access to 100% of that money. They can take it as income, as capital, or they don’t have to touch it at all – the choice is theirs!
Passing money down to the next generation
If the individual who has passed away was under the age of 75, all of the money in that fund is inheritance tax-free forever. However, if the individual was over 75 when they died, anything that the beneficiaries draw out is subject to income tax at their marginal rate.
The benefits to this are that once the pensions are in the benefactor’s name, they can then leave the pension, or whatever’s left of it, to their children without paying inheritance tax either.
These inheritance benefits are where the inheritance tax savings come from. In an old-style pension, anything that is passed down to the children or beneficiaries is subject to inheritance tax based on the value of their assets. However, with the new flexi-access drawdown rules, all of that pension can be passed down to the next generation inheritance tax-free.
Then, as long as they do the correct paperwork, the money can be passed to the next generation inheritance tax-free, and so on.
Flexi-access – a whole world of opportunity
The inheritance tax benefits from flexi-access open up a whole new world of opportunity with pension death benefits. Not only does this new pension offer a great opportunity for inheritance tax planning, but it also offers total access to any pension that’s in a flexi-access drawdown.
However, a word of warning here. Many of the old pensions from 15–30 years ago won’t have access to flexi-access drawdown rules, so they must be carefully assessed.
If people are heading towards retirement, they need to have their options professionally assessed by an Independent Financial Adviser to see if their old pension needs to move into a flexi-access drawdown plan.
Because once you are in one, anybody over the age of 55 can take anything they want from it, any time they want – subject to the lifetime allowance, of course. You can also draw up to 25% of the funds tax-free.
Any income that’s drawn over that amount is then subject to the marginal rate of the clients.
Using flexi-access for passive, tax-free income
That’s where extra planning can make a big difference, because some clients might not have reached their state retirement age yet, but they’ve finished working, so they don’t technically have any income.
In this situation, we can then mix and match the tax-free cash lump sums, and use the flexi-access drawdown rules to make use of all their allowances. This way, through careful planning and management, we can reduce their taxes and give them a nice income until they reach state pension age.
So, in summary, the flexi-access drawdown pension scheme is one of the best things to ever happen to pension schemes in my lifetime.
It offers great additional benefits to the passing down of money to loved ones and potentially saves you from paying costly inheritance tax. Once you reach the age of 55, it also gives you complete flexibility over what you draw, how you draw it and when you draw it.
Just make sure that you have it well managed by a good Independent Financial Adviser.
I hope this was useful. Feel free to email me directly for any further information at firstname.lastname@example.org.
The views expressed in this article are those of the author and do not constitute financial advice. Applewood Independent Ltd is authorised and regulated by the Financial Conduct Authority. For financial advice designed for you and your specific circumstances, please contact the author using the contact details provided in this article or, alternatively, contact the Applewood Independent Ltd office on 01270 626555.
The value of an investment can go down as well as up. Past performance is not a guide to future performance.
Accessing pension benefits early may impact on levels of retirement income and your entitlement to certain means tested benefits.