After decades of working and saving hard, many people understandably look forward to the idea of enjoying the rewards during a long and comfortable retirement.

But sadly, life can sometimes have other plans, which can lead to far less comfortable questions about what happens to your pension savings after you die. How will your wealth be passed on? What are the implications for those set to inherit? Will they be forced to deal with unexpected tax liabilities?

For anyone yet to consider these issues within their financial planning, there are some important points that can be helpful to factor into your thinking.

Passing on defined contribution pension pots

Generally speaking, pension scheme administrators or trustees have discretion to pass on the unspent money remaining in defined contribution pension pots, whether accumulated via a workplace or personal scheme. This scenario can allow benefits to be passed on free from inheritance tax because they are not counted as part of your estate.

Currently, if you die before the age of 75, it could also be the case that beneficiaries do not pay income tax on remaining pension funds. This typically changes if you die after reaching 75, however, when income tax will be due on withdrawn funds.

Beneficiaries are generally nominated by the holder of the pension plan via an Expression of Wish or Nomination form. Individuals might identify one particular beneficiary or possibly several who will be allocated a proportion of the pension savings, although it’s also important to also note that some schemes will have rules dictating who can be nominated.

Where discretion applies, pension providers or trustees are not absolutely obliged to adhere to these wishes, but they will take be taken into account on the death of the scheme member. As such, it is important to reflect on your choice of beneficiaries regularly to ensure it fits with your current wishes, and to make any updates as necessary – particularly in the wake of any major changes to your family dynamic.

Implications of setting out instructions

It some cases, however, administrators or trustees of a pension scheme do not have discretion over how death benefits are paid out. Rather, an individual might have opted, where allowed, to follow a path of direction, setting out explicit instructions that must be honoured and thereby retaining full control over the pension bequeathing process. However, this approach can mean that the value of the savings is counted among an individual’s estate, potentially making them liable to Inheritance Tax.

Inheritance tax is payable at 40% for the value of the estate that is over the nil rate band of £325,000. It does not typically apply, however, to bequests made to a spouse.

There are other specific situations where inheritance tax can come into play in relation to retirement savings. An example is retirement annuity contracts, also known as Section 226 pensions, which were a type of defined contribution pension scheme available prior to 6 April 1988.

RACs were available to individuals who had taxable earnings from a self-employed trade or profession as well as those who were in non-pensionable employment before July 1988. An important difference between RACs and new-style pension plans is that death benefits in RAC plans were not automatically written into trust. As such, they would form part of an individual’s estate on death and could be liable to Inheritance Tax.

Writing RACs into trust

Writing RACs into trust offers the potential to avoid this situation, while also affording the scheme member an opportunity to allocate death benefits to chosen beneficiaries, rather than proceeds simply being counted among their estate.

Whether this is the right path to follow, however, will depend on the individual’s particular circumstances, needs and objectives. It is also worth noting the existence of rules relating to writing these plans into trust, in particular with the “transfer of value” from the estate, which could still cause an Inheritance Tax liability under certain conditions.

This example only serves to underline the complexities that can surround passing on your retirement savings. With so many variables to consider for each scheme and every personal situation, expert guidance and professional advice can help ensure as much of the money you have accumulated over your working life is passed on to loved ones in the manner that you wish.

The information contained within this communication does not constitute financial advice and is provided for general information purposes only. No warranty, whether express or implied is given in relation to such information. Vintage Wealth Management or any of its associated representatives shall not be liable for any technical, editorial, typographical or other errors or omissions within the content of this communication.