If it's not broken...

One of the more notable announcements to come out of the government's autumn statement in November was the indicated rise in the state pension to £119.30-a-week from April 2016.

The £3.35-a-weak increase this represents may not have a significant effect on the majority of individuals' day-to-day lives, particularly given the rate of inflation and the fact that individuals will be required to work longer prior to being able to receive a state pension, the decision at least follows the government's plans first laid down in the summer of 2014, and introduced in the Taxation of Pensions Act 2014 to alter the taxation of pensions.

The new rules mean that those who have worked and saved into a pension throughout their lives will be able to pass it onto their families, tax free.

The rules are particularly advantageous where a pension owner dies before the age of 75, as the pension fund can be paid tax free in the form of an income drawdown payment, or as a lump sum within two years of death. If the pension owner was over the age of 75 at the time of death, the fund will be subject to income tax.

Even though these new favourable tax concessions have been in effect since April 2015, I have witnessed a considerable number of clients who have encashed their pensions as a lump sum during their lifetime. In my view, caution needs to be exercised by anyone considering encashing their pension fund and receiving a lump sum during their lifetime, particularly given the new rules introduced by the 2014 pensions act.

The draw of receiving what, in many cases will be a considerable cash sum following the encashment of a pension fund, may simply prove to be equivalent to the bright flashing lights of Las Vegas. But given time and the peeling away of the bright exterior, it may soon become apparent that the wrong decision has been made when it comes to planning for financial security in later life. Financially sound individuals may find themselves in a vulnerable position by taking such steps.

I recently came across an estate where the deceased (P), aged 56, drew down a lump sum from their pension plan during their lifetime. The knock-on effect of this was that the value of the estate had increased, which in turn increased the inheritance tax exposure of the estate.

P's executor ended up paying a considerable sum in inheritance tax, as the lump sum had taken P over their available inheritance tax nil-rate band. Unfortunately, P was unable to spend the proceeds of the pension fund as they had hoped to prior to their death.

It is estimated that the population share of those aged 80 and over will increase to 10 per cent by 2050, rising from four per cent in 2010.

Old age and elderly care often come hand in hand. Individuals should, therefore, really be considering whether increasing the capital value of their estate will have an effect on their future liability to pay care fees. Without a crystal ball to gaze into, this is an impossible question to answer.

However, with funds set aside in a pension fund and with the implementation of the Taxation of Pensions Act, there is scope to ensure that a benefit can be derived from a pension fund on the holder's death.

Traditionally, bypass trusts have been used to ensure that the value of a lump sum pension benefit falls outside of a deceased's estate on death. However, given the new benefits that are available to owners of large pension pots, who are likely to have other financial means and do not require the drawdown of assets during their lifetime, the Taxation of Pensions Act provides additional benefits and may avoid the need for such trusts. 

David King is a solicitor at Hugh James

He writes the regular vulnerable clients comment in Private Client Adviser

Copyright & permissions