The impending one-year anniversary of pension freedom is an opportune moment to take a step back and look at some of the behaviour they have resulted in.
The freedoms were undoubtedly a progressive development – giving people choice and control over how they access their retirement savings.
However, with any changes there can be tempting circumstances that the unscrupulous might seek to benefit from, or where the wrong decision can lead to a poor outcome for the people involved.
1. Not nominating your beneficiaries
No excuse for this one because it is easy to avoid but it is likely to be one of the most common mistakes. Everyone must make sure they have nominated their beneficiaries for their pension pot on death.
If you don’t, it may be that your fund can only be paid out to a non-dependant beneficiary as a lump sum, not as a regular income. If the death is over the age of 75, payment as a lump sum and not income could create additional tax charges.
2. Stripping out funds before a divorce
A pension pot could be one of the most valuable assets that an individual has and on divorce, the assets of both parties are likely to be aggregated prior to sharing.
Could one party who foresees a divorce on the horizon seek to spend some of their pension to avoid it being included in any legal arrangements?
3. Spending the pension of a minor
Consider an acrimonious divorce where on death of a pension holder the fund is passed to a minor – it could just happen that the guardian of the minor is the other half of the divorced couple.
Care will be needed to control whether that money is actually spent solely for, or on behalf of, the children rather than lavish holidays for the rest of the family.
4. Family disputes on death
We live in a litigious society and figures from the Ministry of Justice suggest a growth in family disputes for a number of reasons – the high property values at stake, complex family structures and the availability of legal advice.
The Ilot case earlier in the year challenged the ability to leave a family member out of a will – could such a situation be transposed to pensions where a pension holder for whatever reason wants to leave the fund value to charity?
5. Transferring schemes when in ill-health
Pension freedom has led to an increase in pension transfers as people move to consolidate into a plan that offers the new pension freedoms.
However, if you make a transfer while in ill-health and die within two years, then it could be that HMRC assess your pension for inheritance tax.
6. Ongoing family disputes
Consider a situation where a father or mother decides to discuss their pension options with their adult children – they have a defined benefit pension scheme with a pension of say £40,000 per annum or an equivalent transfer value say £1.5m.
Within the defined benefit pension there is the provision for a dependant’s pension on death but the children are too old to be dependants.
The parent thinks that he/she would like the secure pension but the children would like them to transfer as they would be likely to benefit from any remaining fund on the parent’s death.
Immediately you have the recipe for a family dispute even though the parent should have the final decision.
7. Age 75 rule
We currently have a situation where the tax treatment of a pension pot on death changes significantly at age 75.
Death before age 75 means benefits can be paid tax-free, death after age 75 means such benefits will be taxable at the recipient’s marginal rate. On a large pension fund, the arbitrary age 75 rule could have a significant impact on the amount a beneficiary receives from an inherited pension.
Pensions and retirement are important issues and following the pension freedoms the sums of money available in one go can be significant.
There is not doubt that with pension freedom also comes complexity and an element of pension responsibility.
Mike Morrison is head of platform marketing at AJ Bell
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