Saving the best for last
Anyone who risks exceeding the Inheritance Tax threshold can limit the impact of death duties by simply spending the right assets.
This year, it is estimated that almost 40,000 estates will be liable for Inheritance Tax (IHT)1. It’s a reminder to those whose total assets risk exceeding the current IHT threshold of £325,000 of the perfectly legitimate ways to limit the impact of death duties on their family.
Gifting is perhaps the most popular way to reduce your IHT liability. You can make gifts worth £3,000, free of IHT, to children or grandchildren each year, including contributions to a Junior ISA or a child’s pension. You can also make larger gifts, but the catch is that you need to survive for seven years for these to completely move out of your estate. Thus, while gifting mitigates some of the effects of death duty, it doesn’t always give you the scope to completely wipe out an IHT liability.
Pensions, on the other hand, offer investors an effective – if unexpected – way to avoid some of the worst effects of IHT. Recent reforms to the way pension benefits can be paid out to loved ones have opened new estate planning opportunities. Furthermore, they have changed the way many investors are using and designating their funds in retirement.
All things must pass
Strictly speaking, pension pots have always fallen out of the scope of IHT. However, prior to April 2015 there was a 55% tax charge on lump sums paid to beneficiaries from any defined contribution (DC) pension that was already in drawdown.
However, last year former chancellor George Osborne announced that, regardless of whether a DC pension is already being drawn or not, it can pass tax-free to any beneficiary as long as death is before 75. Even after 75, nominated beneficiaries do not pay IHT, only Income Tax at their marginal rate, and then only when the money is withdrawn from the pension.
In light of the changes, those who have the financial means are starting to ring-fence their pension so they can pass it on to the next generation – potentially free of tax – while using other assets to fund retirement.
“It makes sense to spend the assets that are liable for IHT and keep the ones that are not,” says Ian Price, Divisional Director at St. James’s Place.
“You can avoid passing an IHT problem to your family by living off the assets you have outside of the pension plan first [such as ISAs and savings], while keeping the value of the pension pot as high as possible,” he says.
Passing on pensions is done through completion of an ‘expression of wish’ form. This tells the trustees of the pension scheme to whom they should pay death benefits. It’s important to keep this updated, especially when either your own circumstances or those of your intended beneficiaries change.
Window of opportunity?
Any contributions you make to your pension attract tax relief on the way in and accumulate income and gains free of tax once inside. So, as well as valuable estate planning opportunities, saving into a DC pension provides many other attractive benefits.
But speedy action may be needed to get money into DC pension plans tax efficiently, as it is widely thought that the tax reliefs available to pensions may come under close scrutiny in the government’s Autumn Statement on 23 November.
There is, of course, no certainty that any changes will be made but if you are considering making an investment for your retirement and have cash to do so then it may pay to act sooner rather than later.
The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time and are dependent on individual circumstances.
1 Office for Budget Responsibility, March 2016