Case study: Getting the pension nomination right

The background

Michael is 78 years old and his wife, Susan, is 68. They have a grown-up son, Andrew, and two grandchildren. Susan is in good health, whereas Michael has the usual sort of challenges befitting his age.

Their total estate in scope for inheritance tax is worth about £900,000, including the house. Michael receives a company scheme pension payment every month, 50% of which will continue to Susan when Michael dies. Michael also has a SIPP worth about £300,000.

Michael has heard rumours of the changes to IHT on pensions and wants to know what practical steps he can now take.

The recommendation

David, Michael and Susan’s financial adviser, explains that, at the moment, pensions are usually exempt from IHT. But from April 2027 that is proposed to change, and pensions will be brought into the scope of IHT. Although the Chancellor announced this change in her Budget speech last October, we have not yet got the final detail of how this will work in practice. HMRC recently consulted on the technical detail, but most respondents came back saying that it would be difficult to implement the proposals as outlined, and changes should be made.

It could therefore be that the Treasury is in a listening mode and finds a better way of applying tax on pensions when someone dies.

Dave outlines areas Michael and Susan may want to consider in the meantime.

The first is the expression of wishes nomination form for the SIPP.

Under the current rules, the trustees of a pension scheme normally decide who should inherit any unused pension funds. A pension saver can complete an expression of wishes (or nomination) form nominating someone to inherit the fund. Trustees will take into account the form when they are making the decision, along with other evidence, for example any Will, or representations from people wanting to inherit. However, trustees aren’t usually bound by the nomination. Instead, they are free to make their own choice.

If the person the trustees decide should inherit is either a dependant of the pension saver or someone nominated by them, then that person can choose to take the inherited pension fund as an income through drawdown or as a lump sum. Otherwise, generally, the person can only take a lump sum. Michael has already nominated Susan to inherit his SIPP should he die, with the intention that Susan will then nominate Andrew to inherit.

The issue with this is that if Susan dies after April 2027, which is likely given her age and health, then Andrew could face paying IHT on, at least, part of the SIPP.

David talks through changing this so that Michael nominates Andrew instead. That way if Michael should die in the next two years, then Andrew should inherit the SIPP and pay no IHT.

Assuming he’s still living, Michael can change his nomination form back to Susan from April 2027, so she can inherit the SIPP, and with the spousal exemption she won’t pay IHT.

This solution only works because Susan has enough money from other assets to live on and doesn’t need the pension for an income.

The other action David recommends is to start the process of considering whether any money in the SIPP is in excess of what Michael and Susan need, with a view to deciding whether to extract the money to spend it, gift it, or shelter it from IHT. If needed, they can put a plan together to achieve this, once they know the final details of how pensions will be taxed on death.