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Using pension nominations with wills to reduce client tax liabilities

Reviewing use of death benefit nominations and wills is a simple but potentially very effective piece of financial planning. Mike Morrison, head of Platform Technical, AJ Bell provides a case study example

The new pension rules have made it more important than ever to ensure client beneficiary nominations are up to date. This is a simple thing to do, yet many people won’t think to do it on their own. This is where advice really adds value because not only is it important to make sure they are up to date but some careful planning can also deliver a better outcome for clients.

Let’s take Kevin as an example. Kevin had been an adviser for a number of years but had never been as busy as he was following the introduction of the pension freedoms in April.

One thing that had come to the fore was the whole issue of pension scheme death benefits and the need to review beneficiary nominations and expression of wish forms. Kevin was really pleased with the outcome of a recent case he had been able to find a solution for using the new rules.

Mr John Johnson was a 75-year-old widower with a grown-up son and daughter. His daughter lived at home and his son was an IT manager who was married with twin daughters himself. John’s aim was to leave the house to his daughter and divide up the rest of his estate between his son and his granddaughters.

About five years ago, Kevin had advised John to update his will. When his wife had died a year ago she left her entire estate to John, leaving her nil rate band untouched and transferable to him. John still expected his estate to be below the combined nil rate bands for IHT – as long as his pension policy, which was written under trust, was excluded.

John had his house, a pension policy and some other bits and pieces. The house was worth about £250,000, the pension £200,000, and his other savings and assets amounted to nearly £200,000.

In an attempt to divide up the money efficiently, Mr Johnson had previously filled in the expression of wish form in favour of his son, who had earmarked the money for an extension to his house.

In his will he had left the house to his daughter and cash sums to his two young granddaughters, which generously totalled £100,000 each.

Kevin had been reading about the new pension death benefit rules and he had had a few thoughts as to how things could be arranged more efficiently, so he’d arranged a meeting to go through the proposed changes with John and his family.

As he saw it, if the benefits were paid to John’s son upon his death after age 75, they would be taxed at his son’s marginal rate. This would be the case if paid as a lump sum or as an income from 6 April 2016 and John’s son was currently a higher rate taxpayer.

However, if John’s son was instead paid an equivalent amount of £200,000 from the will, there would be no tax payable, assuming the assumptions about his estate were correct.

The nomination and expression of wish could then be changed in favour of the granddaughters, and if the benefits were designated to provide them with an income they too would be liable for marginal rate tax, but at a far lower rate than John.

As the benefits will be taxed at the marginal rate of the recipient where the pension holder dies over the age of 75, a key advice point was to balance the tax position of the potential beneficiaries with other requirements that they might have, for example the need for capital to pay off a debt.

Kevin also realised that for the full range of choices to be available to the beneficiaries upon John’s death, John would need to nominate them in his lifetime.

With some careful planning, Kevin was able to minimise some of the tax that may be payable by John’s family as a whole.

The review of nominations and potential beneficiaries was certainly an exercise Kevin would be going through with all of his clients.

At AJ Bell we have seen significant evidence of this type of planning – the number of death benefit nominations that have been updated since April has increased 350% compared to the previous year. It is a simple but potentially very effective piece of financial planning.

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