Could your family end up paying 40% tax on your pension?

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BB8PNH A portrait of a senior man looking up retire retired thinking problems senior; man; old; elder; elderly; male; person; pe
BB8PNH A portrait of a senior man looking up retire retired thinking problems senior; man; old; elder; elderly; male; person; pe



The new pension rules make it far easier to leave your pension to a family member after your death. However, the experts are warning that a small mistake on your pension documents could cost your family tens of thousands of pounds in inheritance tax.

The pension rules are changing so much that it's hard to keep pace. However, if you are gong to avoid this horrible mistake, it pays to be aware of the rules surrounding leaving your pension to your loved ones after your death.

The raft of pension changes which will take effect in April next year now include the ability to pass your pension onto your loved ones after your death, without being hit with a punitive tax. In order to qualify you will need to be a member of a defined contribution scheme who has not converted it into an income through an annuity, but is instead taking money directly from the pot through draw-down.

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The money left in the pension when you die can be passed onto your family. At the moment this is immediately subject to tax at 55% on the total value of the pension pot passed to relatives.

Under the new rules it will pass tax free if you are under the age of 75, and will be taxed through income tax (at the recipient's marginal rate) if you are over the age of 75.

However, experts at Hargreaves Lansdown have warned that if you're not careful, the entire pension pot could be subject to inheritance tax - so you could end up paying 40% tax on it. Inheritance tax is payable on the value of your estate over £325,000 for individuals or £650,000 for couples. If your entire estate is worth more than this, the whole pension pot could be taxed.

It's relatively straightforward to avoid this - the problem is that where people are unaware of this requirement, they may skip a step and land their family with an inheritance tax bill.

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George Osborne Woos Savers and Pensioners with Budget
George Osborne Woos Savers and Pensioners with Budget


Avoid the tax

To avoid your family paying inheritance tax, when you take out the pension you need to state who you want your pension to go to when you die - so than rather than going into your general estate it goes to someone specific directly.

Danny Cox, head of financial planning at investment company Hargreaves Lansdown says: "That means filling in the nomination form when you take out your pension. Otherwise on your death the money could end up being paid into your estate and your family could have to pay inheritance tax on it."

Find out how much pension income you can expect

You need to complete this form, and keep it updated if your personal circumstances change. If, for example, you are divorced or bereaved and you haven't updated this form, the pension company may decide that your wishes are unclear and the pension will be paid into your estate - where it becomes subject to inheritance tax.

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