Inheritance Tax on your pensionPosted on: 21 November 2019 by Peter McGahan
There are many methods to mitigate Inheritance Tax, but a simple one is the use of your pension. Peter McGahan explains.
Inheritance Tax (IHT) is as popular as a party-political broadcast forced into the middle of your favourite sports programme.
A 40% tax on assets you have acquired through blood, sweat and tears seems mildly disappointing.
2018/19 was a great year for Inheritance tax collecting, with an extraordinary £5.4 Billion of assets swept away.
How much of that really needed to be paid, and were there methods of easily mitigating it?
Looking at allowances, no Inheritance Tax is payable on the first £325,000 of the deceased estate and a further allowance of a residence nil rate band can also apply. In 2019/20 where the deceased leaves a residence, or the sale proceeds of a residence, there is a residence nil rate band of £150,000.
If your estate is less than this, your beneficiaries won’t have tax to pay, but be careful not to forget hidden benefits that may form part of your estate later, like your life insurance, pension lump sums etc.
There are many methods to mitigate Inheritance Tax, but a simple one is the use of your pension.
A common criticism/concern about a pension is that it is locked away for too long. Some prefer to save into an ISA, or other accessible savings plans, and you have to weigh up the benefit of that accessibility versus the tax losses.
The freedom and choice reforms significantly improved the tax position and availability of death benefits in a pension.
Aside from contributions made into a pension when the investor is suffering from a terminal illness, a pension can be completely free of IHT.
Each year an investor can contribute up to £40,000 per year into a pension which immediately falls outside of the estate for Inheritance Tax, and just as important, no IHT on the growth of the money.
With a Personal Pension, it can normally pass tax free if you die before age 75, as long as its paid out as a lump sum or drawdown within two years of death. After age 75, your beneficiaries will pay tax at their marginal rate of income tax.
As your pension is not covered in your will, you need to stipulate with your pension provider via a nomination form who the beneficiaries will be. Those beneficiaries can also nominate the next beneficiaries, so your pension pot will cascade down through your generations.
Before 2015, this wasn’t possible as death benefits had to be for dependants only. This meant the fund at some point would have to be paid out as a lump sum if there were no future dependants.
Now the pension can be passed to anyone who was either a dependent, or just nominated as a beneficiary.
Added to these changes was the introduction of a ‘successor’. A successor could be nominated by the current beneficiary to receive the income drawdown after death, allowing benefits to pass from beneficiary to beneficiary whilst staying outside IHT.
Nominating the beneficiaries also gives them more choices about how they receive your pension either via an income or as a straight lump sum. For example, a beneficiary could take a drawdown income where they take just what they need, and leave the rest in a tax free environment for future generations.
Indeed, you could also nominate a family trust as the beneficiary, if that suited your needs.
Not every pension will allow this however, so be careful to check if you have an older style pension scheme and that your scheme is outside the estate. If it isn’t, transferring to a newer style scheme for all its income flexibilities should be considered immediately.
Naturally if you are considering a transfer, be careful not to lose any other benefits if you transfer.
Be careful also to ensure you have beneficiaries nominated at your pension scheme and keep them up to date. Some beneficiaries may be higher rate of tax, so paying to their spouse or dependents may be more preferable.
About the author
Peter McGahan is Chief Executive of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.
If you have a question on Inheritance Tax or pensions please call 01872 222422 or visit WWFP.net.
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