Following the Government’s announcement in the October 2024 budget, from 6th April 2027, pension funds will no longer be exempt from inheritance tax (IHT). This means any remaining pension funds on death will be considered part of your estate and could be taxed at 40%, depending on the total value of your estate. This change will particularly affect those who had hoped to use pensions as an IHT-efficient way to pass on wealth.
Here are several strategies you may wish to consider to help mitigate the potential impact of this change after April 2027.
Assets left to a spouse or civil partner remain exempt from IHT. If you’ve named your children or unmarried partner as beneficiaries, you could inadvertently trigger an unnecessary IHT bill.
By prioritising your spouse or civil partner, pension funds can be passed on free from IHT, giving them the flexibility to later distribute the wealth in a tax-efficient manner. Make sure to review your Expression of Wish form to ensure it reflects your current intentions.
Currently, if death occurs before age 75, beneficiaries can typically inherit the pension tax-free. However, from April 2027, if death occurs after age 75, the remaining pension may be subject to both income tax (at the recipient’s marginal rate) and IHT.
One potential strategy is to withdraw your 25% tax-free lump sum before turning 75. If you don’t plan to spend this cash, we can consider investing these funds in a more IHT-friendly strategy to help reduce the potential tax burden on your estate.
Gifting remains a dependable strategy for reducing Inheritance Tax (IHT) and can be effectively used with pension planning. Generally, any gifts made more than seven years before death are exempt from IHT.
However, don’t overlook the ‘gifting normal expenditure out of income’ exemption. Regular gifts made from surplus pension income – provided they’re consistent in timing and amount, and do not affect your standard of living – can fall immediately outside your estate.
If appropriate, using your pension to support your lifestyle now may be the simplest and most effective IHT strategy.
Despite the upcoming changes, continuing to fund your pension remains one of the most tax-efficient ways to save for the future. Contributions still benefit from tax relief, investments grow free from Capital Gains Tax, and up to 25% can typically be withdrawn tax-free, subject to the Lump Sum Allowance.
Here are further estate planning tools to consider:
A whole-of-life insurance policy, when written in trust, can be a practical way to provide funds specifically to cover any future IHT liability. As the policy pays out on death and is held in trust, the proceeds do not form part of your estate.
To optimise its effectiveness, premiums should ideally be funded from surplus income, avoiding any additional IHT implications.
Transferring assets into trusts or making substantial lifetime gifts can help reduce the value of your taxable estate. Additionally, certain qualifying investments, such as AIM-listed shares, can benefit from Business Relief, potentially becoming IHT-exempt after two years.
These strategies can be valuable, but they do carry additional risk and complexity. Professional advice is essential to ensure they align with your wider financial goals and risk tolerance.
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