The farmers are in arms about changes in inheritance tax; For the rest of us, I suspect that complaining about IHT on our pension after the Budget is the new form of “humble bragging”. In the words of one advisor: “The inheritance tax has become a class issue.”
The problem is more serious if you or your parents are over 80 and expect to live beyond April 2027, when the government plans to include pensions back into inheritance tax (IHT). You may be looking for quick solutions that you can find.
For the last decade, there has been no IHT to pay pension assets left to the family. So if you had other sources of income, such as an Isa or a property, you cleverly saved your pension to spend until the end.
Under the new rules, if the value of your estate exceeds the nil rate bands (which, if you are married and own a home, total £1m), your beneficiaries will inherit less than half of your pension. This is because a 40 percent tax will be applied first; Then your children will pay income tax on the profits. If they are in their 50s or 60s, they could be at the peak of their earning power. Depending on whether they are basic, top or additional taxpayers, when they inherit that pension they will pay a combined IHT of 52, 64 or 67 per cent plus income tax.
If the addition of your pension savings brings the total value of your estate to more than £2 million, the nil rate band for property left to direct descendants begins to disappear – at £1 for every £2 above the threshold . Once it goes away, advisers say its beneficiaries could face a combined tax liability of more than 80 percent. Another thing to humbly brag about?
First, there may be no rush to act. On average, at age 80, you have 10 more years to live. Whereas, if you have a younger, healthier spouse, your IHT bill will be even further away – wealth (including pension) left to a spouse or civil partner is exempt. So the IHT “issue” only really arises when you are the surviving spouse.
“It may well be that many older couples in long-term relationships decide to get married,” says Gary Smith, financial planning partner at wealth manager Evelyn Partners.
I guess it’s kind of a quick fix.
If you’re not in the mood for romance, could you consider doing charity work? Leaving 10 per cent of your net worth to charity can reduce the rate of IHT paid on the rest of your estate to 36 per cent.
Otherwise, the most popular action suggested is to “strip” her of her pension to pass it on during her lifetime. If you haven’t cashed out your 25 percent tax-free lump sum cash, do that first. After that, you will be able to earn an income; Since annuities are generally not sold after age 75, you will need to withdraw them directly from the pension fund.
Yes, you will pay income taxes on the amount withdrawn, but your beneficiaries will also have to do so later (possibly at a higher rate). Additionally, if you can pay a lower income tax rate upon withdrawal than the relief you received upon contributing, you have still “won” against Income. “If you have £500,000 left in your pension at the age of 80, chances are you have received quite a lot of tax relief on pension contributions,” says James Baxter, founder of wealth management firm Tideway Wealth.
Even if you now have a total income of £150,000, in total you are paying 34 per cent income tax. That still leaves you “up” if you received a 40 per cent relief on pension contributions.
But what to do with the money withdrawn from your pension? Gifting is the best and simplest solution, and it’s fun. RBC Brewin Dolphin research found that 70 per cent of Brits who had donated at least £1,000 to family members found the gifts impacted them positively.
The rules on lump-sum giving involve a complex web of allowances and the seven-year rule: Live longer and everything you give is free. But the most powerful and relevant giving opportunity for pensions relates to gifts from surplus income.
There is no limit to the amount you can donate immediately without IHT, as long as you can make the payments after covering your usual living costs and pay out of your regular monthly income.
To help your beneficiaries satisfy HM Revenue & Customs, keep records of your regular income and show that you don’t have to cut back on your normal expenses to earn it.
For tax efficiency, encourage recipients to contribute money to their own pensions or Isas.
The concern with gifts is how to pay for the potential costs of care you may need in the future.
An effective way to keep money withdrawn from your pension is to invest it in Aim shares, but highly volatile investments are not a good bet for someone in their 80s. Additionally, post-Budget, IHT is now charged on Aim shares at a rate of 20 per cent.
A more appropriate route is to invest in unlisted investments that qualify for business relief. Portfolios managed by firms such as Octopus and Foresight target less volatile, lower-growth investments in renewable energy, ultra-fast fiber broadband infrastructure and real estate. As long as you live past 6 April 2026, you will get 100% IHT relief on up to £1 million of qualifying investments, provided they have been held for at least two years.
If these quick fixes seem too troublesome, how about we do nothing at all?
Keeping your money in the pension means it can continue to grow tax-free and benefit from the powerful effect of compounding. If you earn a 7 per cent annual return on the money, Tideway Wealth estimates that the IHT paid at the time of your death will be recovered within 20 years.
That’s why Baxter says: “Try to leave your pension accounts with someone who can keep them invested for 20 years without having to draw on them. The grandchildren are the obvious beneficiaries.”
Moira O’Neill is a freelance money and investing writer. Email: moira.o’neill@ft.comX: @MoiraONeill,Instagram @MoiraOnMoney