How your pension could be your greatest estate planning ally in the coming years

16 May 2023

Preparing your wealth for the next generation’s benefit can be an intense process, with protection, your will, trusts, property, and investments all thrown into the mix. 

In particular, the amount of Inheritance Tax (IHT) your beneficiaries may pay could have come up in estate planning conversations, both with your close family and your financial planner if you have one.

One often-overlooked estate planning ally that could significantly reduce your estate’s IHT liability is your private pension pot. 

Read on to find out how your pension could help you plan a tax-efficient transfer of assets before you pass away.

The IHT thresholds are frozen until 2026, meaning your estate could pay a higher amount than anticipated

Before we delve into how your pension can help you reduce IHT, it’s important to note why it is so crucial to be paying attention to IHT during the estate planning process.

IHT is usually paid at 40% on taxable assets, including cash, investments, and property. The nil-rate bands, meaning the thresholds under which you do not pay IHT, have been frozen at their current rates until 2026. 

These nil-rate bands are:

So, as your assets naturally appreciate in value over the coming years, they are more and more likely to breach these nil-rate bands and be liable for IHT. 

The increase in IHT receipts is already happening as a result of these freezes, which were originally brought in by former chancellor Rishi Sunak in 2022. Indeed, Professional Adviser reports that between April 2022 and March 2023, HMRC received £7.1 billion in IHT – up £1 billion from the previous year. 

As house prices increase and investments see long-term returns, your estate could fall into this tax trap too. 

Your personal pension pot is not usually liable for IHT

Fortunately, your pension can help you combat the effects of these IHT nil-rate band freezes.

Unlike many of your other invested assets, your pension is not usually subject to IHT when it is passed down to the next generation upon your death. 

Your personal pension, which includes employer pension schemes and self-invested pension pots (SIPPs), can often be passed down without incurring an IHT bill, even if its value surpasses the nil-rate bands that apply to most other assets. 

In addition, if your annuity agreement has a benefit that includes the income, or part of it, being transferred to your spouse upon your death, this is unlikely to carry an IHT liability.

This is the key reason why your pension could be your greatest estate planning asset. By staying invested as long as you can, you could leave your children and grandchildren with a tax-efficient sum to spend IHT-free when you’re gone. 

Leaving your pension “until last” during retirement could greatly benefit the next generation

Now you are aware that your personal pension does not usually carry an IHT liability, it might cause you to reconfigure your retirement plans slightly. 

Remember: it could be beneficial to discuss any big changes to your financial plan with an expert before you proceed.

Indeed, leaving your pension “until last” during retirement, and instead taking your initial retirement income from other investments – that will generally form part of your estate for IHT purposes – could be beneficial. You could fund your retirement lifestyle, or a portion of it, using: 

Even if you do take your personal pension early in retirement, you could opt for flexi-access, meaning you can use it as a “top up” for your retirement income rather than the main source of it.

That way, by the time you pass away, much of your invested wealth may be held in your pension, and could be inherited by your spouse, children, and grandchildren without incurring an IHT bill. 

It is important to note here that while IHT could be mitigated, your beneficiaries might pay Income Tax on the pension they inherit, depending on the age you pass away. 

If you pass away under 75, your loved ones can usually draw from your pension without paying Income Tax – but if you die after 75, beneficiaries are likely to pay Income Tax at their marginal rate upon withdrawal.

The removal of the Lifetime Allowance means you can now build an unlimited amount of pension wealth 

One recent development that makes your pension even more of an IHT ally is the removal of the Lifetime Allowance (LTA) tax charge, and the proposed abolition of the LTA. 

In his spring Budget, chancellor Jeremy Hunt announced that the LTA would no longer apply to pension withdrawals from 6 April 2023 onwards, and would be fully abolished in a future Finance Bill. 

Until the 2023/24 tax year, the LTA marked how much pension wealth an individual could amass in total. It stood at £1,073,100 before it was removed; pensions that surpassed this figure could have paid up to 55% in tax upon withdrawal.

Now the LTA no longer applies, pension holders are free to invest a potentially unlimited amount into their pensions – considering annual limits – without worrying about this additional withdrawal charge. 

However, it is important to be aware that, if elected, the Labour Party has vowed to reinstate the LTA. While the next general election is not due until December 2024, it could be prudent to keep this in mind while making contributions.

Nevertheless, under current legislation, if you continued to boost your pension contributions throughout the coming years, your beneficiaries could receive a substantial inheritance from your pot – all while reducing the IHT they may pay when you die.

Get in touch

To discuss making your pension your greatest estate planning ally, email or call 0161 8080200.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. 

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.  

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.

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