One of our clients is to benefit from their deceased spouse’s pension scheme and has been advised that, as their spouse died below the age of 75, they have the choice of receiving a tax-free lump sum or to take tax-free withdrawals from a Flexi-access fund.
The main tax consideration here will be Inheritance Tax (IHT) and, to a lesser extent, income tax.
The important thing to remember is that a pension scheme, including a dependent’s/nominee’s Flexi-access fund, is outside the scope of Inheritance Tax. Therefore, they need to consider the options available in the context of how this will affect the client’s personal IHT position. It would appear that the spouse was a member of a Money Purchase (Defined Contributions) scheme.
Taking the tax-free lump sum will increase our client’s personal estate and potentially risk being charged to IHT at 40% whereas leaving funds in the Flexi-access fund will remain out of the estate and can be passed on free of IHT.
Although there may be an initial attraction of taking a lump sum or high withdrawals, this could be potentially expensive in IHT terms if the funds remain in the personal estate, whether as cash or converted into personal investments or assets. In addition, in view of the £2m estate cap applying to the Residence Nil Rate Band, the consequences of taking a lump sum or large withdrawals need specific consideration where there is a risk of a personal estate approaching this threshold.
Also remember that income on the Flexi-access fund will be tax-free within the fund, whereas income from personal investments will be chargeable to income tax. Therefore, taking a lump sum or large withdrawals for personal investments, would have an income tax cost in addition to the potential IHT cost.
On the death of our client, any remaining funds within the Flexi-access fund can be paid to “qualifying persons” income tax-free if our client dies before reaching 75, or charged to income tax at the recipient’s marginal income tax rates if our client dies over the age of 75.
There is no right or wrong decision here, but our client should consider all tax repercussions before they decide what is best for them 
 Reproduced from Croner Taxwise