Should we make our grandson a beneficiary of a Sipp?

Kay Ingram, chartered financial planner, says:

It’s important to consider who will receive pension funds after the pension owner’s death as part of your overall financial and estate planning. Pension pots can’t be given away during an individual’s lifetime, but any funds not spent, at the date of death, can be left to others or charities. They aren’t part of the estate of the deceased and are usually free of inheritance tax (IHT).

Distribution of the pension fund is determined by the trustees of the Sipp (usually the scheme administrators) who consider the nomination, or 'expression of wishes' form completed but are not bound by it. Keeping nomination forms up to date, following changed circumstances, is vital as the trustees will be guided by this – not your wife’s will. During her lifetime she can change the nominees as often as she likes.

Generally, assuming any surviving spouse or civil partner has sufficient income and capital, it can be tax advantageous to leave pension funds to children or grandchildren, as this is usually free of IHT. Before committing to this it is important to first consider the needs of any surviving partner. If their own pensions and investments are unlikely to be sufficient to maintain their standard of living, the pension pot could be left to them. They, in turn, can nominate younger generations of the family to receive any unspent pension on their death.

In addition to avoiding IHT when passed on, pension pots enjoy several tax privileges which persist after they are inherited by others, as follows:

• The invested funds suffer no income or capital gains tax.
• Inherited pots don’t count towards the recipient’s lifetime allowance for pension savings, (£1,073,100 currently) and aren’t subject to the lifetime allowance charge ongoing.
• Inherited pensions remain outside the estates of those who receive them. And the recipients can nominate others to receive any funds in them on their deaths.
• While an individual cannot access their own pension pots until age 55, (57 from 2028), there is no age restriction on access to inherited pots.

Death before age 75

• If the original pension owner dies before age 75, the pension is tested against the lifetime allowance of £1,073,100 for the last time. Any excess will suffer a lifetime allowance charge of 25 per cent of the excess if it is withdrawn as income, or 55 per cent if withdrawn as a lump sum.  
•  All subsequent income withdrawals are tax free, regardless of the tax status of the recipient.

Death after age 75

• If death occurs after age 75, there is no lifetime allowance charge, as the last test is applied at  75.  
• Subsequent withdrawals of income are taxed as the recipient’s income, at the rate applicable as and when they withdraw them.

Children and/or grandchildren?

In determining who your wife nominates to receive any unspent pension funds consider the needs of the potential recipients.

Whether you leave the pot to children first, who may in turn pass it on, or to grandchildren depends on what you wish to achieve with the money. Things to consider are:

•  the size of the pension pot, is it small or life changing?

• your children’s overall financial position;
• how they would use the funds;
• the income tax rate they would each be likely to pay on withdrawals, if they inherited the fund on your wife’s death after age 75;
• their ability to invest  the funds wisely.

Your grandson has a personal income tax allowance of £12,570 per year, so could withdraw this amount with no tax to pay, whereas his parents may pay more tax. While he is a child, his parents can make decisions for him but at 18 he will be in sole charge of his inherited fund. This could be an opportunity to learn about investing, or an onerous responsibility.

As he is the first of the next generation, you need to consider how you would even things out between your children and future grandchildren, so that everyone gets a fair share. It’s important to discuss this with the family and be transparent in any decisions made, so that no one will feel unfairly treated.