Over the last five tax years the amount paid in inheritance tax (IHT), nearly all of which is collected on death, has risen by over 70%. However, there is one area where the IHT rules have become noticeably more favourable pensions.
A range of reforms has made defined contribution (money purchase) pensions, such as personal pensions, a valuable tool in estate planning. The broad rules are now:
• Pension death benefits are generally free of IHT.
• If death occurs before age 75, any benefits – lump sum or as income – are also free of income tax.
• On death on or after age 75, benefits are subject to income tax, based on the beneficiary’s tax position.
The freedom from IHT and, before age 75, income tax means that from an estate planning viewpoint leaving your pension untouched until at least your 75th birthday will often be the sensible course of action.
If you are thinking “Good idea, but what do I live on?”, then the answer depends upon a variety of factors. Drawing on existing non-pension investments could be a solution, as the example shows.
Pension vs investments: the IHT case
Gordon has an estate worth £800,000, with £350,000 in a portfolio of funds, and another 350,000 in a self-invested personal pension. He needs £20,000 a year to top up his existing pension income, which after tax means taking about £23,500 a year from his pension plan.
If Gordon dies before age 75 having received £20,000 a year net for 10 years (and ignoring any investments returns or changes in the nil rate band) his beneficiaries would have £840,000 instead of just £725,000 – and increase of £115,000 or over 15%.
Income Source
Portfolio (£)
Pensions (£)
Value of estate
600,000
800,000
IHT on estate
(110,000)
(190,000)
Net estate
490,000
610,000
Pension fund – IHT-free
350,000
115,000
Total to beneficiaries
840,000
725,000
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
The value of tax reliefs depends on your individual circumstances. Tax laws can change. The Financial Conduct Authority does not regulate tax advice.
