When a spouse who has had a pension scheme and dies before reaching the age of 75, the choices for receiving tax-free funds by the surviving spouse needs to be considered properly and in its entirety. Both Inheritance Tax and Income tax needs to be looked in the context of the surviving spouse’s own circumstances before decisions are made.
A pension scheme falls outside the scope of Inheritance Tax, therefore, consideration of the options available in the context of how this will affect the surviving spouse’s personal IHT position. Taking the tax-free lump sum will increase the personal estate and potentially risk being charged to IHT at 40% whereas leaving funds in the fund will remain out of the estate and can be passed on free of IHT.
Although there may be an initial attraction of taking a lump sum or high withdrawals, this could be potentially expensive in Inheritance Tax terms , if the funds remain in the personal estate, whether as cash or converted into personal investments or assets.
In addition, in view of the £2m estate cap applying to the Residence Nil Rate Band, the consequences of taking a lump sum or large withdrawals need specific consideration where there is a risk of a personal estate approaching this threshold.
Also it is worth remembering that income on the fund will be tax-free within the fund, whereas income from personal investments will be chargeable to income tax, therefore taking a lump sum or large withdrawals for personal investments would have an income tax cost in addition to the potential Inheritance Tax cost.
On the subsequent death of the surviving spouse any remaining funds within the pension fund can be paid to qualifying persons free of income tax, if the surviving spouse died before reaching 75 or charged to income tax at the recipient’s marginal income tax rates if the surviving spouse were to die after the age of 75. There is no right or wrong decision here but care should be taken to be aware of the tax repercussions before making any decisions as this will depend on the surviving spouse’s particular circumstances as no one size fits all solutions is possible.
The information contained in this article is for general information purposes only and does not constitute advice, Whilst we endeavour to keep the information up-to-date and correct, we make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability for a particular purpose. We recommend that professional advise should be taken from a suitably qualified expert before undertaking any action.