Passing pension fund on to grandchildren

[sharpener]

I am 78 y/o considering how to mitigate impending IHT on pension savings. Looking at annuities as a workaround with a view to the following:

Buy an annuity with (say) £250k of ~£1M pension pot (already in drawdown, have taken max lump sum but am not drawing income ATM). This should put the £250k out of reach of IHT. Income is taxable in my hands (at higher rate)

Pay net income to grandson as lifetime gifts out of income, not taxable in his hands as they are gifts, invest the funds in a bare trust until required for school fees or other expenditure for his benefit. Annuity would be guaranteed for 17 yrs so lasts until grandson b 2025 is 18

He will continue to receive payments after my death as nominated beneficiary

Will this work?

What is grandson's tax position after my death?

[AGoodman]

I had two thoughts:

- If you died during those 17 years, the guaranteed years of the annuity would still suffer inheritance tax (I believe on the capital value of the remaining years) and then potentially income tax when paid out to grandson.
- I am not sure how the annuity works within the pension wrapper after your death - whether the guaranteed income is paid to your estate or into a pot for your nominated beneficiary. I could be wrong but I don't think it can be paid out to a grandchild as a dependants pension. Maybe the benefit of the annuity can be transferred to him as a lump sum? That is definitely worth checking - as would the taxation of a transfer of the annuity. It could land your grandson with IHT and IT on the net present value of the annuity - which he could not pay as the value is based on future income not yet received.

[sharpener]

Thank you @AGoodman.

After my death I was expecting the annuity to be paid direct to the grandchild as income and this to be taxable in his hands.

This web site https://www.hl.co.uk/retirement/annuities/your-options says " If you die within this time, the income will be paid to your estate or your beneficiaries for the rest of the guarantee period. " which sounds as though there is an element of choice.

Am currently (still) waiting for an impaired life annuity quotation, will be sure to ask what the options are.

IHT position is a bit of a bummer though, can you suggest how I can research this further or what the relevant tax provisions are? If there is no workaround this defeats the idea at the outset!

[sharpener]

A bit more research using google AI gives rise to the following

Until 5 April 2027 the IHT can be avoided by giving the annuity provider the discretion to choose a beneficiary

How it helps now: By naming your grandchild via an Expression of Wish, the provider uses its discretion to pay them directly [Scottish Widows Death and Pensions Guide]. For deaths occurring before April 6, 2027, this completely moves the capital value outside your taxable estate, bypassing IHT

After 6 April 2027 it is caught by the new legislation.

Even if you fill out the Expression of Wish, the rules change for deaths occurring on or after April 6, 2027 [Standard Life Pension IHT Guide]. Under new legislation, the remaining value of the 17-year guarantee will face a "double tax trap" if your total estate exceeds your tax-free thresholds [Saga: Pension Death Benefit Burden:Tax Type How It Applies to Your Grandchild Inheritance Tax (40%)]

The remaining capital value of the 17-year guarantee is added to your estate value and taxed at 40% [L&G Pension Annuities and IHT Guide.Income Tax (0% or Marginal)

If you die at or after age 75: The grandchild pays income tax on the annuity payments at their own marginal income tax rate

Note: If your grandchild is under 18, the income will be held in a wrapper trust by the provider until they reach adulthood, but the tax rules remain the same [Saga: Inheriting a Pension under 18]

Alternative Quoting Strategies to Consider

Because passing a guaranteed annuity income to a grandchild carries a heavy tax footprint under the upcoming laws, you may want to ask your provider to quote two alternative options:

Alternative A: Value Protection (instead of a Guarantee Period). Instead of a 17-year income stream, you can quote "Value Protection" [Scottish Widows Death and Pensions Guide]. If you die early, the provider pays out the original purchase pot minus any income you already took as a lump sum directly to the grandchild

But is the Value Protection payment within my estate for IHT purposes, or taxable on the grandchild, or free of IHT?

Alternative B: Use the Income to Gift Right Now. Rather than setting up a long guarantee period to pass on after death, you can quote a standard single-life annuity with no guarantee period (which gives you a much higher monthly payout) . You can then immediately gift the extra surplus cash to your grandchild while you are alive {PensionBee: Annuities and Gifting Surplus Income]. Under HMRC rules, gifts made out of "surplus income" that do not impact your standard of living are 100% exempt from IHT immediately.