Pensioners warned over loophole that leaves their loved ones paying inheritance tax - and five tips on how to beat it
Millions of savers could miss out on the chance to pass on their nest egg tax-free simply because they’ve failed to tick a box on a pension form.
Last week it was revealed that a 55 per cent tax on pension funds passed on to relatives as an inheritance was going to be axed.
From next April, anyone who has not touched their savings will be able to leave them as an inheritance.
Death duty: Those who fail to fill in a nomination form when they take out a pension could see their family having to pay inheritance tax on the pension pot
But experts are concerned that many who hope to leave their retirement pots to a loved one may find it instead falls under inheritance tax rules - and so incurs a 40 per cent charge.
This is because they failed to fill in a form stating their wishes when they took out the pension. As a result, the pension may be paid out to their estate, rather to an individual.
Once this happens, the pension - which is normally exempt from inheritance tax - will suddenly be charged the death duty.
Inheritance tax is paid on 40 per cent on any assets over £325,000 for individuals and £650,000 for couples.
Danny Cox, head of financial planning at investment company Hargreaves Lansdown says: ‘It is absolutely vital to state who you want your pension to go to when you die.
‘That means filling in the nomination form when you take out your pension. Otherwise on your death the money could end up being paid into your estate and your family could have to pay inheritance tax on it.’
Technically, pensions are exempt from inheritance tax. But few people pass them on because money left after a saver’s death is subject to a punitive 55 per cent charge.
The only exceptions are if the person receiving the cash is the saver’s husband or wife or a dependent child aged 23 or under.
If the saver dies under the age of 75 and the money in the pension fund is untouched, it will escape the charge. But under the new rules from April, the only tax charge will be the beneficiaries’ standard rate of income tax when they draw the pensions.
However, many savers will not realise they can pass on their pension in this way only if it is stated on an ‘expression of wish’ form.
In some cases, savers forget to update this form to reflect changes in their circumstances. For instance, if they get married, have children, get divorced or suffer a bereavement.
When it is not clear who should inherit the pension, those running the scheme may order that the money must be paid back into the saver’s estate. This immediately takes it out of being a pension and, as such, means it suddenly qualifies for inheritance tax.
If this pushes their estate over the inheritance tax threshold, the family will lose £40,000 out of every £100,000 in the pension.
It would not matter if someone’s will states where they want their pension paid - it has to be a formal instruction to the pension company for it to remain out of inheritance tax.
The Association of Member Nominated Trustees, a trade body representing those in charge of running pension schemes, says that as family circumstances have become ever more complex, there has been a rise in disputes about which family member should inherit a pension when a saver dies without making their intentions clear.
It says the scrapping of the 55 per cent death tax will mean it becomes increasingly challenging for trustees to make a decision over who should inherit pension cash.
Malcolm McLean, senior consultant at actuarial firm Barnett Waddingham, says: ‘The new rules coming into force from next April make it more important than ever that savers make their wishes about who should receive their pensions clear and kept up to date.’
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