What happens to my investment portfolio when I die?

There was a collective sigh of relief last week when Chancellor Jeremy Hunt confirmed that HMRC would not be introducing a new “death tax” on pensions in the recent Autumn Statement.

Earlier in the year, the government had aired plans that it was to start taxing income withdrawals made by beneficiaries, if a pension member died before the age of 75.

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Currently, if somebody dies before the age of 75, no income tax will be payable on any withdrawals their beneficiaries take from the pot - no matter whether they take lumps sums or draw income – and this position is now expected to remain in place.

However, while this volte-face is undoubtedly welcome, it has provided a sage reminder of the complexity around what happens to our pensions and investments when we die and the level of tax that could be payable.

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Private pensions

If you have a defined contribution (DC) pension and you die before the age of 75, any remaining funds can be passed on to your loved ones and there will no income tax to pay. If you die after your 75th birthday, your chosen beneficiaries may need to pay income tax on it.

This applies whether you have not accessed your pot (your “uncrystallised fund”) or converted it into flexi-access drawdown.

If you used your DC pension to buy an annuity however, the situation is different. In these cases payments will stop when you die – unless it’s a joint policy and payments will carry on being made to your spouse or partner, or you selected a guarantee that ensures payments are made for a specified period of time.

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Any money that is inherited from a DC pension will also fall outside your estate and be free of inheritance tax. However, it’s important you let your pension provider know who you would like to get the money by completing a nomination or expression of wishes form and keeping it up to date. Without this information your pension provider will be forced to make the decision itself.

If you have a defined benefit (DB) pension that pays a guaranteed income, what happens when you die will depend both on your family situation and the specific rules for your scheme. If you are married or have dependent children, some income would normally be maintained for them and this income would be taxable. However, if you are single and don’t have financial dependents, payments would normally stop.

The state pension

Although not strictly part of your portfolio, it’s important to know what happens to your state pension on death.

When you die, in most cases, state pension payments will stop. There are some circumstances where limited benefits could be passed on to a spouse or civil partner, but that would depend on when you both reached state pension age and the benefits that had been accrued.

For example, if you reached state pension age before 6 April 2016, and had built up entitlement to the “additional state pension”, your spouse might be entitled to part of that payment when you die. Alternatively, if you reached state pension age after that date and were in receipt of a “protected payment”, your spouse could be entitled to inherit half that.

Both of these payments would be made alongside their regular state pension and would be subject to income tax.

The state pension is complicated but you can find out more about what your spouse or civil partner could potentially inherit here.

Individual Savings Accounts

You can leave your individual savings accounts (ISA) to whoever you like when you die and can specify the details in your will. However, it’s important to note that the tax-free status of these pots will only be protected if that money is passed on to a spouse or civil partner.

This is facilitated by a temporary additional ISA allowance on top of their own, that is equivalent to the amount of money they are inheriting. This is known as an additional permitted subscription (APS) and it can cover every ISA that you are passing on, even if they are with different providers. So if you pass on £50,000 from three ISAs, your spouse will have a total ISA allowance in that tax year of £70,000 (the APS plus the standard £20,000 ISA allowance).

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The money from inherited ISAs will be paid as cash, but to use the APS, the beneficiary will need to pay the money into their current ISA or arrange a new one within three years (or 180 days after the estate administration is finalised, whichever is later). The ISA manager would claim the APS on their behalf.

Once you have died, your ISAs will also form part of your estate which means they could be subject to IHT if it’s value exceeds the nil rate band. Again, if they are passed on to a spouse or civil partner, this won’t be an issue as this type of transfer is IHT free. However, if your ISA is passed on to someone that you aren’t married to, it will form part of your estate and could potentially be subject to tax at 40%.

If your ISA portfolio is invested in qualifying AIM shares that have been held for at least two years before you die, then you can swerve IHT under business relief rules.

General investment accounts

If you have funds or shares in general investment accounts (GIA) outside your ISAs or pension, they won’t receive any favourable tax treatment when you pass them on.

Although any capital gains that have built up on these investments would be wiped out by your death, they will still form part of your estate when you die, which means IHT could be payable on the money. The only exception would be if they were passed to your spouse or civil partner as those transfers are IHT free.

If your GIA is a joint account, then the account will go to the co-owner, irrespective of what is written in your will.

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Premium Bonds

Premium Bonds can’t be transferred to other people, so to pass them on they will need to be cashed in.

The bonds don’t have to be cashed in immediately though and can be held for up to 12 months after the date of your death. During this time you will still be entered into the monthly prize draw and able to claim prizes – potentially boosting the amount your beneficiaries inherit.

Investment bonds

If you have an investment bond that was in your name only, it will pay out when you die. But, if it’s in joint names it will carry on running until you have both died.

Although investment bonds might allow you to defer tax, they are not tax free and tax could be payable on death. How much tax will be paid will depend on gains, and if sizeable gains have been made, you might need professional advice to ensure it is managed as tax-effectively as possible.

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Estate planning checklist

• Make sure you have written a will providing instructions over who should inherit your wealth
• Pensions cannot be included in your will, so if you have a DC scheme make sure you have completed an expression of wishes form, outlining who should inherit remaining funds when you die
• Ensure your will and your expression of wishes forms are kept up to date – especially if you get married or divorced
• ISAs must go to a spouse or civil partner for their tax-free status to be protected.