Firms promoting and distributing the Lifetime ISA (Lisa) due to be introduced in April next year will be required to issue specific risk warnings at the point of sale, according to published proposals from the regulator earlier this week. It has also said that they will have to make clear the potential early withdrawal charge of 5 per cent, as well as any other charges that apply.
Here at Independent Financial Adviser Rutherford Wilkinson, we have been concerned that the Lisa vehicle, where a government bonus is added to contributions, is diverting attention away from the progress made in the introduction of workplace pensions where employer contributions as well as tax relief are added to those made by the individual. Larger savings can be amassed through pensions when compared to using the Lisa. Aimed at the under 40s and directed at young savers making contributions at an early age where later circumstances in life are not predictable, the exit charge is also a punitive tax that some are likely to fall foul of.
Passing on your pension
A key benefit to pensions since the introduction of the freedoms is these funds can be used to preserve family wealth and be passed down to the next generation. In this way, pensions can last a lifetime and beyond and not just a financial dependant can benefit, but also someone else you chose to nominate. A successor can be selected by the nominee to receive the benefits on their death. The rules are as follows:
· If you die before age 75, any funds paid from your pension to beneficiaries are tax-free, regardless of how these are paid. The lifetime allowance may still be an issue if you have a large pension fund.
· If you die after age 75, the inheritor will pay income tax at their marginal rate on any withdrawals from the fund, whether as a lump sum or income, in the year it is paid to them.
To pass on pensions effectively, it’s important to ensure that your nominations and expressions of wishes (the form required) are up to date and to find out how flexible your current pension scheme is around death benefits. Many pension schemes do not offer the ability to pass on a pension as an income fund, but only as a lump sum.
In most circumstances it is more tax-efficient following the death of an individual over age 75, to pass on a pension as a drawdown (or income) fund, rather than a lump sum. A pension income can be withdrawn by the nominated beneficiary gradually within tax allowances, rather than simply paid as a taxable lump sum in a single tax year. This is because even if the recipient has no other income, a fund over £43,000 will suffer 40% tax on at least part of the fund.
Taking into consideration further tax efficiencies, if your estate and your fund are going to children in different tax positions, you may want to consider leaving the pension funds to the lower taxpayer and the non-pension assets to the other. This is because the lower taxpayer will have less tax to pay on withdrawals. It is important the pension provider is aware of the reasons for the differences, as they may use the Will as a second opinion. The pension provider has discretion over who receives the pension fund, and your expression of wishes are not usually binding on them, so they will look at a number of factors before deciding who is to benefit from your fund.
The fund must be either paid out as a lump sum, or allocated to a drawdown pension, within two years of death. However, there is no requirement to take any income, but just a designation into drawdown. The same rules apply when the funds are passed onto a successor.
It can be appropriate to nominate a number of different people (for example your spouse and children or grandchildren), but then have a separate expression of wishes confirming that your main beneficiary is to be your spouse, but you have included your children in case you and your spouse die at the same time.
IHT exemption for pensions
For those with an inheritance tax (IHT) issue, it may well be preferable to consider spending non-pension assets, rather than reduce pension funds, which are effectively free from IHT in the majority of circumstances. This is because any other funds held over the “nil rate band” (£325,000 for an individual, £650,000 for a couple) are subject to 40% tax on death. Whilst a fund is held in a pension, its investments are also protected from income and capital gains tax.
There are circumstances, however, where it is possible to lose the exemption for pensions from IHT. Where a pension is transferred by a plan holder in poor health and they subsequently die within the next two years, HMRC may challenge the plan and it could become subject to IHT. Although this stance is itself under challenge in the courts, it is advisable to position your pension correctly when you are fit and healthy.
Putting in place your pension nominations as early as possible in accordance with your wider retirement planning is crucial to ensure that tax efficiencies are achieved and family wealth is preserved. Early preparations are advised, but in terms of the Lisa, it would be wise to consider the benefits of pension saving against this option.