Your pension could be one of your most valuable assets: don’t overlook it when planning your estate

The first cuts to inheritance tax in more than a decade could be around the corner. This is following hints from the Government that inheritance tax reductions and changes are set to form part of the upcoming Budget. Should this arise, this could reduce or even eliminate the inheritance tax bills faced by many after the passing of a loved one.

Much of the current debate around inheritance tax is focused on the family home. However, any moves by the Government to cut inheritance tax could also benefit those who have built up valuable pensions over the course of their working lives – or more specifically, the loved ones they intend to leave those pensions to.

While the family home, family heirlooms, jewellery and lump sums sitting in bank accounts are often the first things people think about when planning their estate, a pension could be one of the most valuable assets they have to pass onto their loved ones. However, like any element of an inheritance pot, it is important to protect any pension earmarked for loved ones. Failure to include a pension in estate planning, and to take steps to limit any tax bill that might be faced by those inheriting it, could substantially eat into the value of that asset. Furthermore, certain decisions made by individuals around pensions over their lifetime will ultimately determine whether it can be passed onto loved ones or not.

Approved Retirement Funds

As you approach retirement, you typically need to decide between an annuity and an Approved Retirement Fund (ARF).

A big advantage of ARFs is that any money remaining in your ARF after your death can be left to your next of kin or family. This isn’t always the case with annuities. It is important however that people specify in their will who they want their ARF to be left to. Otherwise, the ARF will slide into the residue of the estate, and it may not be distributed as it had intended to be.

It is also important that people do what they can to limit the tax bill faced by those that they pass their ARF onto. In this regard, people should carefully consider whether they leave their ARF to their spouse alone rather than to both their spouse and children.

One tax-efficient way to pass on an ARF is for it to transfer into an ARF in the name of a spouse or civil partner. Neither inheritance tax nor income tax are triggered for the spouse or civil partner in this instance, though the spouse or partner will pay income tax on any drawdowns from the ARF.

If some or all of an ARF left to a child, the tax treatment varies, depending on the age of the child. ARF benefits payable to a child under the age of 21 may be subject to inheritance tax, though no income tax will be due. ARF benefits payable to a child over the age of 21 are subject to income tax at a rate of 30pc, regardless of the size of the fund. However, inheritance tax is not payable.

Annuities

With some annuities, an individual’s pension simply stops when they die – even if they pass away shortly after retiring.

This means that the individual – and their dependents – could get very little back for all of the years they have been paying into a pension. For this reason, a guaranteed annuity is something an individual could consider if they have family. With a guaranteed annuity, the pension will continue to be paid to the individual’s estate for a certain amount of time (usually for either five or ten years) – even if they die shortly after buying their annuity. These annuities are more expensive than the ones which do not come with a guarantee – but they offer peace of mind.

Another useful option for those with family is a joint-survivor annuity – which is often bought by married couples. With these annuities, a pension continues to be paid to the surviving partner when the spouse dies.

PRSAs

Personal Retirement Savings Accounts (PRSAs) have become more popular in recent years[LM1] , and are a pension product often considered and used by the self-employed. Furthermore, recent changes in the tax rules around PRSAs have increased the appeal of these products. As is the case with any pension product, those with PRSAs should understand what happens to the pension benefits built up in it after they die. With a PRSA, all funds go to the individual’s estate tax-free after they die, with beneficiaries subject to the usual inheritance tax rules.

However, like ARFs, it would be important for an individual to specify in a will that they want their Vested PRSA left to their spouse or other family members. Otherwise, the Vested PRSA could slip into the residue of the individual’s estate which may not necessarily be what the individual had intended.

Birds-eye view on pension

Regardless of the type of pension, it is crucial that it is taken on board by people when planning their estate and where it can be passed onto loved ones, care must be taken to ensure it is included in a will – and that the will stipulates to whom the pension benefits are to pass to.

People should ensure they have a full understanding of all the pension benefits they have built up over their lifetime when planning their estate. There may be pensions which were saved into in an individual’s early career which have been forgotten about or lost track of. Importantly, the money in a pension is held in trust so any money left in an old pension which has been forgotten about is still the pension holder’s money and still there. Hiring a qualified financial advisor can help track down old pensions, so can the register of company pension schemes available from the pensions regulator, the Pensions Authority (pensionsauthority.ie).

Those who have a pension at work should be sure not to overlook any death-in-service benefits they might have. With an occupational pension scheme, should you die while in service, a maximum lump sum of four times your salary can be paid to your estate tax-free, with any surplus going towards an annuity or ARF.

Time will tell what, if any, inheritance tax cuts or changes the Government has in mind. With regard to pensions specifically, there could certainly be merit in the Government considering nuanced inheritance tax-free thresholds to differentiate between those family members that are inheriting money that effectively acts as much-needed income replacement (such as a pension) and those receiving a financial bonus.

Whatever unfolds in the Budget this autumn, the changes mooted are a timely reminder of the importance of estate planning – and why pensions should not be overlooked in this regard.

Source: Glenn Gaughran, Head of Business Development, ITC Group

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