Can I access my tax-free cash without compromising the ability to pass on the residual pension funds to my beneficiaries on death with no tax to pay?
A common theme with clients at all levels is a strong desire to ensure that the tax-free cash sum from their pension is secured at the earliest opportunity. There is a continuing fear that a current or future government may alter the tax treatment of such lump sums, although such fears have proved unfounded to date.
However, a core issue with drawing such a lump sum is the need to ‘vest’ your pension in order to access it. For most people, their tax-free cash would be 25% of their accumulated pension pot, so a person with a £1million pension could take £250k. The way the rules work tell us that you are allowed 25% of what you are actually crystallising into a pension, so you need to ‘vest’ the full £1million, with the £750k of non-lump sum monies being used to provide a taxable income. This means annuity or drawdown as options.
Assuming that no income is needed, many opt for drawdown on the £750k and need not draw income until they need to. On the surface of it, there is no issue. However, the real problem is with death benefits.
Prior to drawing the tax-free cash (or age 75 if earlier), the full pension pot was payable tax-free to beneficiaries on death (without assessment for inheritance tax either). However, a pension pot of money already in drawdown will be subject to a 55% death benefit tax if paid out as a lump sum! A spouse or other financially dependent beneficiaries have certain options when the holder dies. They can opt for a lump sum payable (less 55% tax), or the pension fund can provide them with a taxable pension income.
For people who chose to protect their benefits at A-day using Primary Protection (either as their main protection, or as a ‘back up’ to Enhanced Protection), there is a potential planning opportunity.
Primary Protection allows people to take their protected lump sum from any arrangement they hold in any proportion with the use of segments. The pensions can be set up as segmented policies which means that some segments can be crystallised for the purposes of taking out the 25% lump sum. The balance of their remaining fund can be left ‘uncrystallised’ (i.e. still free of taxes on death before age 75).
It is therefore very important for people with such protections to consider their options and priorities very carefully in order to maintain key death benefit advantages on their accumulated funds.
Date: 31st July, 2013
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