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A new legacy - how pension wealth can benefit charities

01 June 2016

Until now, fundraising from 'legacy income' has generally involved encouraging individuals to add a charity beneficiary to their Will. In 2012/13, over 8,000 estates left money to a charity (where the estate was valued above the inheritance tax threshold). This can be an important source of funding for charities where high net worth donors are involved.

The changing nature of the UK pensions system however opens up new opportunities for wealth to be left to a charity via a different route. To tap into this potential new source of 'legacy income', it will be helpful for charities and their advisers to understand more of the legal framework. A donor's will also remain relevant in some cases and a limiting factor will be the nature of the specific pension scheme rules which apply in any given case.

New pension rules

New rules arrived on 6 April 2015 which changed how pension funds can end up in the hands of chosen beneficiaries. The action required by donors is to name the charity or charities on their Beneficiary Nomination form, in the case of modern defined contribution (DC) pensions.

Where someone dies under the age of 75, all lump sum pension payments from DC schemes are tax free, to family, friends or charity beneficiaries (though uncrystallised funds are still tested against the lifetime allowance). Where someone dies after the age of 75, there are two scenarios in particular where a pension lump sum can end up in the hands of a charity free of tax:

  • the donor is single and doesn't have children under the age of 23;
  • the donor is a widow(er) and doesn't have children under the age of 23.

In other situations where someone dies after the age of 75, 45% tax may be deducted when part or all of an unspent pension fund is paid to a charity. This tax rate may come as a surprise to many donors and charities, and is a hangover from the way the pension rules have evolved in recent years.

The case study below sets out some of the possibilities with the new rules at their most flexible (which assumes the donor has a modern DC style pension).

Case study

Sylvia is married to John and they don't have children. Sylvia's SIPP is worth £500,000. Sylvia completes a Beneficiary Nomination to name her husband as her preferred beneficiary. On Sylvia's death aged 67, the administrators of the SIPP review Sylvia's circumstances, and use their discretionary powers to select John as the beneficiary. John is wealthy in his own right, and decides not to take the £500,000 as a lump sum (which would increase his own estate for inheritance tax purposes). Instead, he takes a drawdown arrangement, which means he can dip into the (tax-free) funds as and when it suits him.

John then completes a Beneficiary Nomination (which he finds he can do online with the pension company), and he chooses to name his two favourite charities on a 50/50 basis. On John's death aged 79, £300,000 of the pension is still remaining. A lump sum of £150,000 can be paid to each charity tax-free by the pension administrators: no tax applies on these payments to a charity as John left no 'dependants'.

What if Sylvia and John had children under the age of 23, and Sylvia had completed a Beneficiary Nomination to name a charity, instead of naming her husband? On Sylvia's death aged 67, the pension lump sum could be paid tax-free to the charity. If instead Sylvia had nominated John as the pension beneficiary, and on his death aged 79 he has nominated two charities as beneficiaries, and the children were still under the age of 23, a tax charge of 45% would apply on the funds paid to the charities.

Not all pensions are the same

For charities looking to increase their 'legacy income', understanding how donors can leave unspent pension funds to a charity is important. The favourable tax treatment of a pension as an investment vehicle means significant wealth may be held within pensions and may not be controlled by someone's will.

For a donor keen to benefit their favourite charity, the key point in practice is that the individual rules of any particular pension will need to be checked, to understand what scope is available for passing on unspent pension savings. The flexibility set out above may not be available. For some older types of pension which pay a lump sum to the deceased's estate, the terms of any will usually sets out who inherits. For more modern pensions, where a donor wishes to favour a charity, the vital point is to keep Beneficiary Nomination forms up-to-date. And charities should watch out for the sting in the tail and the 45% tax charge. This could mean that, with married couples, a charity is only a favoured beneficiary once both spouses have gone and there are no dependants, which removes the 45% tax charge.

Julie Hutchison is the Charities Specialist at Aberdeen Standard Capital.

First published in Charity Finance Magazine June 2016.


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