Changes to Inheritance Tax (IHT) were among the most anticipated in the first Budget from the new Labour government and will worry many people wanting to leave a healthy legacy for their loved ones. In particular, the question of whether pension funds would be affected was on many people’s lips.
Previously, pension funds were free from IHT following your death. This meant that they were often considered the ‘pot of last resort’ when it came to lifetime income provision.
They will now be (potentially) subject to IHT in the same way as other assets, with effect from 6 April 2027.
Whilst this will be disappointing news for those who were preserving their pension funds to pass on to their beneficiaries, still it should be remembered that these funds (if structured correctly) can be passed on free from other taxes if you die before the age of 75.
Pension savings are still very tax efficient from a lifetime income provision perspective. Most people are likely to be lower rate taxpayers in retirement than when they were working. This, coupled with the ability to ‘manage out’ pension funds within tax bands, means that it should be eminently possible to pay a lower rate of tax on pension income than the tax relief granted on the contributions made. Pension funds grow in a tax-free environment.
What can you do about Inheritance Tax?
The change in legislation means that consideration should be given to drawing from them in conjunction with other assets to maximise tax efficiency in the provision of lifetime income. This might enable more net assets to be passed on to your beneficiaries. Monies drawn that are not needed could be gifted away, setting the seven-year IHT running.
It reinforces our general advice to draw tax-free cash by the age of 75 due to death benefits becoming subject to Income Tax after that point.
It might be worth considering reviewing death benefit nominations. Passing funds to your spouse rather than your children might defer an IHT charge until later, and deferring tax charges is our usual course of action.
The change might open up the opportunity to transfer older-style pension funds to more appropriate vehicles. Previously, there might have been a reluctance to do this due to the potential for the funds to become subject to IHT on death within two years of transferring. This might provide flexibility to avoid Income Tax charges on death before the age of 75 introduced by recent changes to legislation.
Contact Mercer & Hole
If you are worried about the changes to IHT and would like to discuss your options, please do not hesitate to contact our Financial Planning team. We are here to help.
