The pension freedoms not only gave defined contribution savers more choice about how they access their retirement savings, but also reduced the tax charges that can apply when a pension is left as an inheritance.
Before April 2015 an uncrystallised DC pension could be paid out as a tax-free lump sum, up to the lifetime allowance, if the saver died younger than 75.
“The introduction of the freedoms have made passing on pensions to beneficiaries a tax-efficient exercise,” says Andrew Megson, executive chair of My Pension Expert.
“Now, pensions are considered to exist outside of an individual’s estate, which means they are not subject to IHT once the DC pension holder dies.
“Even if the pension holder dies after 75, the beneficiary is still able to avoid IHT, although the pension will be subject to a marginal rate of income tax.”
As such, Megson suggests savers withdraw their 25 per cent tax-free lump sum before turning 75. “Otherwise, the sum would be considered as taxable, and the beneficiary would face charges,” he adds.
If using DC death benefits for beneficiary flexi-access drawdown, this provides a survivor with maximum flexibility of access and keeps death benefits outside their own inheritance taxable estate, notes Scottish Widows financial planning manager Bernadette Lewis.
Beneficiary flexi-access drawdown can also reduce tax, adds Lewis. “For deaths under 75, a 25 per cent lifetime allowance charge applies to any excess used for beneficiary flexi-access drawdown – but it’s 55 per cent for an excess lump sum. For deaths over age 75, beneficiary flexi-access drawdown gives a survivor control over taxable withdrawals.”
The fact a pension is not usually part of a taxable estate for IHT purposes is why, perversely, it is often the last pot to draw from after other savings that are part of the estate, notes Uday Tuladhar, JM Finn wealth planning assistant.
Just Group communications director Stephen Lowe agrees: “The [pension freedoms] rules created the possibility for a cascade of wealth with well-pensioned retirees passing on generous funds to children and grandchildren.
"Indeed, why tap into your pension to provide income in retirement when you could first use up other non-pensions assets likely to be subject to heavier IHT when you die?"
Lowe adds: “The blatant generosity of the current rules creates a dilemma for advisers, who will be acutely aware that future policymakers may want to tinker with what they might perceive as a tax loophole in the name of addressing wealth inequality, while clawing back tax relief.
“It’s hard to argue that the death benefit rules are aligned with a wider pension system whose purpose is to provide adequate incomes in retirement, rather than estate planning opportunities for the rich.”
For savers looking to capitalise on the tax efficiency of passing on a DC pension, My Pension Expert’s Megson suggests checking if the scheme enables such bequests.
