How insurers force widows to pay tax on inherited pensions
Reforms were supposed to let inherited funds pass down generations, but some insurers don’t allow it, says Sam Brodbeck
Some of Britain’s biggest insurers are forcing widows to cash in inherited pension savings, dramatically increasing their tax liability. As part of the pension freedom reforms, the “death tax” on pensions was abolished in April 2015, meaning that unspent pensions could be inherited, and even passed on again to succeeding generations, in a highly tax-efficient manner.
But some pension companies, including giants Aviva and Reassure, will pay the pension of certain deceased savers only as a cash lump sum, meaning that the money leaves the tax-advantaged pension “wrapper”. As a result, the person who inherits is likely to face taxes on future income and growth. Crucially, when he or she dies, the savings pot will form part of their estate and potentially attract death duties.
Most firms will let widows or widowers buy an annuity with the proceeds, but at today’s low rates that option will be unattractive to many. Annuities also cannot be passed on through successive generations.
reader Julie Bryant’s husband, John, died in September 2016 just weeks after being diagnosed with liver cancer. He was only 63, meaning that Mrs Bryant could inherit his pensions free of income tax. If he had died over the age of 75 any withdrawals she made would have been taxed at her marginal rate. As the money was inside the pensions at the point she inherited them, she did not have to pay inheritance tax.
However, the majority of Mr Bryant’s £612,000 of unspent pensions was held by companies that will pass the money on to Mrs Bryant only as a lump sum paid directly to her. While she will receive this money free of income tax, it will be outside a pension and so at risk of attracting other taxes as it grows. It will also form part of her own estate when she dies.
In all, Mr Bryant left six pensions with different providers when he died. The majority of the money – nearly £370,000 – must be paid out as cash.
A family friend, Michael Veale, a solicitor, has been fighting the pension companies on Mrs Bryant’s behalf. He has convinced Reassure, a “closed book” insurer, to reverse its position: it will now let her keep the £153,500 Reassure pot inside the pension.
Mr Veale estimated that this would save Mrs Bryant around £116,000 in tax that she, and her estate, would have ended up having to pay if she had taken the cheque as per the original offer.
“I haven’t given up on behalf of Julie,” he said. “Her financial adviser failed but we succeeded. Not everyone will have the bloodymindedness to do that. Most people don’t understand the rules, and would have given up.
“Unless there is wider public awareness, these financial institutions will keep thinking they can walk all over their customers.”
Reassure no longer takes on new customers, so it is not surprising that it has not updated old-style policies. Aviva, on the other hand, is one of Britain’s largest providers, with more than 30 million customers. Yet it refuses to put Mrs Bryant’s inherited pension into a “drawdown” account, as she wishes, or to let her move the money to a provider that will.
A spokesman said: “Under the terms of Mr Bryant’s policy, beneficiaries do not have the right to transfer this type of pension, so alternative arrangements cannot be made in this case. However, Mrs Bryant can take the full pension, £115,770, tax-free and invest the money elsewhere.”
Likewise, a pension fund of £99,000 built up while her husband worked for Mars cannot be transferred out, the confectionery group confirmed. It said: “If a scheme member passes away with funds still in our arrangements, we pay those funds out under a discretionary trust arrangement, which minimises inheritance tax to the estate.”
When the pension freedom rules came into force, providers were not compelled to offer all the new options to savers. Most major firms have updated their more recent policies but millions of pounds still languish in old, inflexible pension plans.
Mrs Bryant could put the money back into pensions, or Isas, but annual contribution limits mean it would take her years, if not decades, to shelter all of her husband’s pension money.