Inheritance tax planning

March 14th, 2018

The issue of inheritance tax continues to grow. Despite the introduction of favourable new rules last April, the amount of inheritance tax collected by the government has reached record high levels and is forecasted to keep rising over the next five years.

If, when you die, the value of your estate falls above your personal inheritance tax threshold (the highest amounts being up to £450,000 if you’re single or divorced, or up to £900,000 if you’re married or widowed, for the 2018/19 tax year), everything you own above it will be taxed at 40%. Typically, it will fall on your family to settle this tax bill, which can often run into thousands of pounds.

There are different ways you can address an inheritance tax liability, and – thanks to rule changes – your pension might be the answer.

Special status

The way HMRC calculates a potential inheritance tax liability is to add up the value of the deceased’s estate.

This includes your property, car, savings and investments.

But, crucially, not pensions. If you’ve a defined contribution pension, it has special status that allows it be passed on without it forming part of your estate. This is not a new development, but what has changed are the rules around inheriting defined contribution pensions – and here is where the opportunity lies.

Before the 2015 pension freedoms, if you died over the age of 75, or after taking money from your plan, your remaining pot could only be passed to loved ones after incurring a 55% tax charge. This has now been scrapped. If you die before you’re 75, your family can inherit your pension tax-free. If you die after 75, they will only have to pay tax at their highest marginal tax rate, rather than 55%, to receive these funds.

The fact it isn’t part of your estate means you can, in theory, have up to £1,030,000 in a defined contribution pension (for

the 2018/19 tax year), and it can be passed on to your family without incurring inheritance tax or any lifetime allowance charges. There may still be tax to pay, if you’re over 75, but it could work out much lower.

Planning your future

When it comes to funding your retirement, these significant changes to inheriting pensions could influence how you use your different savings.

For example, if you have savings and investments not held in a pension wrapper, it might prove more tax-efficient to use these for a retirement income. After all, there are tax implications for withdrawing from your pension, beyond the 25% tax-free element. Withdrawing from your savings and investments could prove more tax-efficient.

One of the key tax advantages of not touching your pension until a last resort is that, compared to other investments such as ISAs, Collectives and Bonds which would all be included in the deceased’s estate for IHT, it will maximise the amount that can potentially be passed down to your loved ones tax free.

Therefore, when it comes to your family’s inheritance – and if your estate could trigger an inheritance tax liability – you might find using your pension is the most effective way of passing on your wealth to loved ones.

A financial adviser can look at your situation and long-term plans, to advise you of the most tax-efficient way of using your savings to fund your future – and beyond. They can help you consider if inheritance tax might be an issue to plan for, and outline your options.

Levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor. The Financial Conduct Authority does not regulate taxation & trust advice.