The wheels of government grind slowly. The Office of Tax Simplification (OTS) first published recommendations for reforms to inheritance tax (IHT) almost two years ago, but ministers have yet to respond in detail.
The Treasury did write to the OTS last month, but only to say it was still considering most of the proposals. And in the meantime, the number of people caught by IHT continues to rise: the £325,000 threshold on estates has not been increased since 2009.
Helping your heirs
If you are worried about IHT, private pensions can be an excellent way to plan for the future. Many people do not realise that unused pension savings can be passed on to their heirs, but this has been the case, other than for defined-benefit pensions, since the pension freedom reforms of 2015. Assuming you haven’t used your savings to buy an annuity, your pension can be left to your heirs. If you die before you reach 75, there is no tax to pay, while if you die later, they’ll pay income tax on what they receive.
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Crucially, pension savings almost always fall outside of your estate for IHT purposes – unlike money and assets held in individual savings accounts (Isas), for example. For this reason, all other things being equal, it makes sense to prioritise pensions when saving for later in life; it may even be worth moving money into them from other savings accounts.
Watch out for the annual and lifetime allowances, which cap the amount you may save in private pension plans without having to pay tax penalties, at £40,000 a year and £1,073,100 respectively for most people. But this caveat aside, pension plans are a much more IHT-friendly store of wealth.
If you do reach retirement with substantial savings outside your pension plans, it is a good idea from an IHT perspective to use these first. By taking income out of your Isas, say, you will be reducing the value of your final estate; by contrast, taking money from pensions has no effect on the bill your heirs might one day have to pay.
It is also worth remembering that everyone is entitled to give away assets in order to reduce the value of their estate. Making contributions into a child’s private pension could be a sensible way to do that, since HM Revenue & Customs will top up the money with income-tax relief.
Everyone gets an annual pension contribution allowance of £3,600, even if they have no earnings at all. For children earning an income you may be able to make even larger contributions. The rules on gifts can become complicated – which is one reason the OTS has intervened – but the basic principle is that you can make gifts worth up to £3,000 each tax year with no IHT implications.
You can also make larger gifts, known as potentially exempt transfers, which fall out of your estate in full assuming that you live for seven years after making them. Do not overlook the role of pensions – both your own and your children’s – in prudent estate planning. It may pay to take expert advice on your individual circumstances, but pensions provide some easy wins on inheritance tax.
David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.
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