Pension Reforms and Inheritance Tax Planning

The latest pension reforms might seem like a breath of fresh air, especially when it comes to inheritance tax planning (IHT). But are they really? Money Marketing dives in to understand what these changes mean for ordinary UK families and their future inheritance.

Understanding the New Pension Reforms

Recent decisions have led to the removal of the lifetime allowance (LTA) from pensions. On the surface, this looks like good news, as it could allow families to plan for inheritance tax more effectively. Pensions, after all, are generally not considered when assessing the value of an estate after someone’s death.

Some might think that this could pave the way for families to rely on other savings during retirement, conserving their pension to pass on to the next generation, or perhaps even topping it up during their lifetime.

However, this isn’t the entire story.

The Real Intention Behind the Reform

The primary goal of this legislative change wasn’t to make inheritance tax planning easier. Instead, it was introduced to encourage skilled professionals to continue working rather than choosing early retirement. In essence, this means that for many families, relying on these reforms for IHT planning might not be the best choice.

When considering pension savings for estate planning, here are some questions to ponder:

1. Can You Pass On Your Pension to Your Loved Ones?

The type of pension you have is crucial. Defined benefit pensions, while providing stable income during retirement, usually can’t be handed down to the younger generations like children or grandchildren. On the other hand, only defined contribution pensions are typically considered in IHT discussions.

2. What’s the Tax Implication for the Beneficiaries?

While pension funds aren’t subject to IHT, other taxes come into play once the funds are accessed. If the pension holder dies before turning 75, the beneficiaries can access the pension without paying any income tax. However, if the pension holder is 75 or older at the time of death, beneficiaries will have to pay income tax based on their tax bracket. This means the benefit of avoiding the 40% IHT could be nullified if the beneficiary falls under the 40% or 45% tax bracket.

3. Can You Top-Up Your Pension Pot Efficiently?

With the removal of the LTA, there’s now the possibility to add to defined contribution pensions. For those who had already reached their LTA or were about to, this change provides new opportunities. However, it’s essential to remember the annual allowance – 100% of your earnings or £60,000, whichever is lower. But beware, if you earn more than £260,000 annually, your allowance might shrink to a mere £10,000.

What Does This All Mean?

Pensions remain crucial in estate planning, especially when considering which savings to spend during retirement. Yet, the elimination of the LTA shouldn’t dramatically alter the way inheritance tax planning is approached.

In the current financial climate, with IHT allowances remaining static and the shadow of high inflation, inheritance receipts are increasing by approximately £1 billion annually. There’s an ever-growing transfer of wealth between generations, and with it, a pressing need for financial advice. It’s our responsibility to ensure families are equipped with the knowledge and understanding to make informed decisions.