I have £300,000 invested in a pension

Release time：2024-05-07 22:01:21 Source：International Index news portal

I have £300,000 in a self-invested personal pension that I don’t need for my living expenses, as I have final salary pension income and Isas that I can draw on for extra tax-free income.

I’m widowed, with six grandchildren, currently aged between 12 and 1, and am considering leaving this pension pot to them, but how does this work if they wanted to take money out of it after I die?

Would they have to wait until they reached 57 to withdraw money from the pension, as people normally would do, or could they take money out earlier?

If they could get the money out earlier, would they have to take it all in one go, or could they leave it in there and draw on it when they wanted to?

I have been thinking that this would be the ideal way to leave them all some money to go towards a house deposit, but I don't want them to wait until they are 57 for it. Hopefully, they’d manage to buy their own home before their mid-fifties. Anonymous, via email

Helping hand: First time buyers are increasingly reliant on relatives to help them get onto the housing ladder

Harvey Dorset of This is Money replies: Being in a position where you can afford to keep a pension untouched for your grandchildren is ideal if you want them to gain a benefit from your savings in potentially the most tax-efficient way.

Sipps, as self-invested person pensions are known, are a popular form of personal pension that allow people to invest within a pension 'wrapper', giving them a lot of control over how what investments they hold.

Many people will have a Sipp in addition to a pension pot built up with their employer, which can either be a defined contribution scheme or defined benefit scheme. 

Those whose employer pensions are good enough to fund their retirement may not need to use their Sipp to live on.

As you mention, you are hoping that your Sipp can help your grandchildren to get on the housing ladder in years to come, and as such wouldn’t be of much use if they can’t access it until they are 57.

The good news is that your grandchildren won’t need to hit 57 in order to withdraw money from an inherited pension, as our experts exaplain below, inherited pensions can be drawn on at any time.

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Furthermore, this could be beneficial from an inheritance tax perspective, although this depends on whether someone dies before or after the age of 75 and then how much their beneficiary earns. 

If someone dies under the age of 75, then a pension can be inherited tax-free - although you should be aware there are calls to end this pension inheritance perk. 

If someone dies after the age of 75, an pension pot falls outside of the inheritance tax net but there is income tax to pay on any withdrawals by their beneficiaries. This means that they could be taxed at 20 per cent, 40 per cent or 45 per cent.

This means that if you die after the age of 75, it is likely to be most tax efficient for your beneficiaries to take money from an inherited pension pot gradually. If you split £300,000 evenly and the grandchildren each took £50,000 as a lump sum and had any other income, then they are likely to be over the £50,270 higher rate tax threshold.

I spoke to two experts about what the best way is for you to leave your money to your grandchildren.

Inheriting a pension: Craig Rickmain, of II, explains inherited Sipps can be drawn on at any age.

Craig Rickman, personal finance expert at Interactive Investor, replies: Firstly, it’s great that you’re planning ahead. Weighing up how you would like your Sipp to be distributed on death can be a bit morbid, but it’s a really important exercise. 

It can reduce friction between heirs, potentially save them some tax, and give you the peace of mind that your hard-earned savings will pass to the intended hands.

There are, however, a few things to unpack here. As you may have found, the pension landscape can be quite complicated.

So, what are the things you need to know? 

Before you do anything else, check that you have completed an expression of wish and nomination form. This tells your Sipp provider who you would like to inherit your pension on your death.

In this instance, you would name your six grandchildren, selecting what percentage each one gets. Note, the funds do not have to be split equally.

While your wishes are not binding - your Sipp provider ultimately decides how the funds are divvied up - they are strongly taken into account. It’s also important to update this form should your circumstances or intentions change at any point in the future, which you can do at any time.

When it comes to inheriting Sipp death benefits, the beneficiaries typically have two options. They can either receive the money as a one-off lump sum or opt for something called beneficiary drawdown.

The latter is where the money remains in a pension wrapper, thus retaining the advantages of tax-free gains and dividends, and the beneficiary has the option to make withdrawals as and when they please. 

Unlike standard drawdown, there are no age restrictions placed on withdrawals so even those below the minimum pension age of 55 (rising to age 57 in 2028) can access the money.

So, how does the tax work on pension funds inherited on death? Although pensions typically escape inheritance tax, your beneficiaries might pay income tax, though this depends on when you die.

If you pass away before age 75 your grandchildren can receive your Sipp funds free of income tax – no matter whether they receive a one-off lump sum or make withdrawals from a beneficiary drawdown plan. 

With regards to lump sum payouts, note a two-year rule applies. This means the money must be paid out within two years of the scheme administrator being informed of your death. If the process takes longer than two years, the money could be taxable.

If you die after age 75, any withdrawals or lump sum payments will be taxed at the beneficiary’s marginal rate in the tax year in question.

 Under the current regime, anything within the basic-rate tax band is taxed at 20 per cent, while those that fall within the higher-rate or additional-rate brackets are taxed at 40 per cent or 45 per cent, respectively.

It might also be worth floating a further option. As would like the money to go towards a house deposit for your grandchildren, they may benefit from receiving the funds sooner. 

You could, therefore, gift the money to them while you’re still alive, enabling them to enjoy the money either now or in the near future. This would involve making withdrawals from your Sipp, then passing the money to your grandchildren.

There are some tax implications this approach. On any Sipp withdrawals, you will pay income tax at your marginal rate, which may reduce what you can pass to your grandchildren. What’s more, the gifts might be subject to inheritance tax if you die within seven years from the date the gifts were made.

So, if you’re happy for your grandchildren to wait until after your death to inherit your Sipp, keeping the money untouched within the pension wrapper should be the best course of action.

Tax benefits: Michelle Holgate says pensions are not usually subject to inheritance tax

Michelle Holgate, financial planner with wealth manager RBC Brewin Dolphin said: With an inherited defined contribution pension pot, beneficiaries can draw on the funds at any age, as payment of death benefits are not linked to their own minimum retirement age. 

Subject to scheme-specific rules, they often have the ability to take the money as a lump sum directly from the deceased’s pension, opt to have the funds paid into a pension in their own name and take drawdown income (which can be done at any age) or even buy an annuity.

If you pass away before the age of 75 then the beneficiaries can generally draw the inherited pension monies free of income tax. 

There is a two-year timescale in which the funds must be designated or the pensions potentially become taxable. An individual has a lump sum and death benefit allowance and if this is exceeded then the excess will be subject to tax. 

The standard allowance is currently £1,073,100. However, if you die post 75 then the beneficiaries will each pay tax at their highest marginal rate of income tax on the withdrawals they take.

Leaving money via a pension can be tax efficient as pension schemes generally sit outside of a person’s estate for inheritance tax purposes. 

As a pension isn’t part of your estate, it does not pass per your will and therefore it is important that you complete an expression of wish form to inform the pension trustees who you would like to benefit from the funds and in what proportions.

Everyone’s circumstances are different and pension rules vary scheme to scheme. I would therefore highly recommend seeking financial advice to ensure that your pension schemes are working as efficiently as they can for you during your lifetime and set up correctly to pass on to your beneficiaries in the way you would want it to on your death.

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