Utilising your pension to cut inheritance tax

Utilising your pension to cut inheritance tax

Pensions usually fall outside of your estate.

Inheritance tax was thought to be ripe for reform in last year’s Autumn Budget but, as it happened, it was left untouched for another tax year. 

What that means is the £325,000 nil-rate band has been in place since 2009, while the 40% standard rate of tax that can apply on any amount above that figure goes back even further than that.

This form of death duty is levied on our estates, which consist of any property, money and possessions.

While we don’t pay it ourselves, it can take a sizable chunk out of what your beneficiaries receive, especially if you are not in control of your estate.

There are many estate planning strategies, ranging from using ISAs and trusts to writing a legally-valid will and making potentially-exempt transfers, all of which we can help you with to form a comprehensive plan.

Another one of these tactics involves using your pension to reduce the value of your estate, ensuring you leave more of your wealth to your loved ones rather than HMRC.

Failing to do this, particularly if you have an estate worth more than £500,000 including your main residence, or up to £1 million if you’re in receipt of your deceased spouse’s full unused entitlement, leaves the door open for the taxman.

Fail to plan is planning to fail

It is easy to ignore inheritance tax. Some people think it’s only aimed at wealthy people, while others mistakenly believe they can take their money with them when they die.

Every individual in the UK has an inheritance tax-free threshold of £325,000. If your estate is worth more than this figure, tax can apply at 40% on everything above this threshold.

Indeed, between April and December 2021, HMRC had collected £507.7 billion – £114.1bn more than the same period a year earlier – although coronavirus-related deaths offer a big caveat

Property is one of the biggest assets that forms part of your estate, and the average price of a UK house was £252,687 in November 2021 – almost 15% higher than March 2020 when the COVID-19 crisis started.

And with both the nil-rate band and the residence nil-rate band frozen up to and including the 2025/26 tax year, it’s easy to see how more and more people will be dragged into inheritance tax’s net over the coming years.

Taking charge of planning your estate has arguably never been more important if you wish to pass on as much of your estate as possible to your loved ones.

What happens to your estate?

Depending on the total value of the assets you own when you die, your estate might be liable for inheritance tax.

The amount of inheritance tax HMRC will collect on behalf of the Treasury will vary, according to the total value of your estate and who your beneficiaries are.

Put simply, inheritance tax won’t apply if you have an estate worth less than £325,000. However, if your estate is worth more than this but you leave everything to your spouse, civil partner or a charity, inheritance tax also won’t apply.

But if you want to leave your estate to direct descendants, such as your children or grandchildren, inheritance tax could apply.

You might be able to leave them your family home as the residence nil-rate band (worth £175,000 per person in 2021/22) helps you to pass on your main residence.

For example, if your home is worth £1m, it’s possible to let your children inherit it without paying inheritance tax, assuming you have no other assets.

With house prices soaring, even the family home allowance is starting to look less than generous in many parts of the country. The good news is, however, your pension could help you cut your potential inheritance tax bill.

How your pension can help

Pensions usually fall outside of your estate for inheritance tax purposes. If you’ve ever nominated a beneficiary to inherit your pension, the pension will not form part of your estate.

As pensions are excluded from the calculation of whether your estate is worth £325,000 or more, the level at which inheritance tax typically becomes payable, they are a tax-efficient estate planning strategy.

Secondly, the pensions system can make it straightforward to pass on certain unused pensions to your beneficiaries, especially if you hold defined-contribution or money-purchase pension plans.

Finally, if you die before your 75th birthday, your nominated beneficiaries are entitled to all of the money with no tax to pay. If you die after age 75, they will still get the cash, but they must pay income tax at their marginal rate. The rules do change in certain situations, so please do check with us.

If you were to use your pension savings to purchase an annuity – an insurance contract paying you a regular income for life or a specified period – you might be able to pass on cash to the people or causes closest to your heart.

The annuity must be set up in the right way when you buy it, selecting options which allow you to pass on payments in the form of income or a lump sum. If this is not done on your death, no further payments will be made.

Annuity rates are determined by the Bank of England’s base rate of interest – which remained at 0.1% from March 2020 before increasing to 0.25% in December 2021 – and competition among insurers, while offering measly returns.

You could potentially reduce any inheritance tax liability by leaving your pension untouched and funding your retirement with other assets that do form part of your estate.

Getting some expert help

If you’re married, you leave your estate to your surviving spouse and you are the first partner to die, no inheritance tax will apply. If your nil-rate band has been unused, your partner can transfer the unused balance and add it to their own, up to a value of £1m.

However, if you have left bequests to others (and lifetime gifts made within seven years of death), your estate might attract inheritance tax if it’s large enough and may use up some or all of the nil-rate band.

As you can see, the rules affecting inheritance tax are complex and getting the details absolutely right is essential. Your wealth and the future of your beneficiaries after you have gone are too important to be left to chance.

We can provide expert assistance to help you minimise inheritance tax, not just by using your pension, but with detailed estate planning to take full advantage of all the strategies.

Get in touch to discuss inheritance tax.

Gift It or Keep It? The Capital Tax Implications

At Egan Roberts Accountants based in Ribchester, Lancashire we can provide you with year round tax advice on capital gains tax and inheritance tax.

Capital Gains Tax (CGT)

CGT is the tax payable on the ‘gain’ you have made from selling an asset which has increased in value.

The gain (proceeds less cost) is reduced by your annual exempt amount of £11,100.

Any remaining gain is taxed at 10% if you are a basic rate tax payer or 20% if you are a higher rate tax payer.

Gift Relief

If you have given the asset away or received less than market value proceeds, you may be able to claim gift relief.

This means the amount chargeable to CGT is the real proceeds you have actually received.

However, this only defers the CGT. The amount of gift relief claimed will become chargeable when the donee sells the asset.

So by reducing your gain, the donee will have a bigger gain later.

More information on gift relief is available here.

Entrepreneur’s Relief (ER)

There are certain criteria which must be met for you to qualify for ER.

The full list is set out here.

In summary, if you are selling all or part of your sole trade or partnership, you must have owned the business for at least 12 months prior to the sale. If you are selling shares (of which you hold at least 5% of total shares), the company must be trading and you must be an employee or officer of the company.

ER reduces the CGT rate to 10% regardless of whether you are a higher rate tax payer.

Gifts to Spouses / Charity

Any assets you gift or sell to your spouse or civil partner are not subject to CGT unless you separated and did not live together for the whole tax year or you have them goods for them to sell on as part of their business.

CGT is not charged on assets given to charity. You may pay some CGT if you sell an asset to charity for more than you paid for it but for less than market value.

Find further information about this here.

Inheritance Tax (IHT)

Lifetime Gifts

If you make a gift during your lifetime to a person, this is known as a PET (potentially exempt transfer), meaning no IHT is payable on the gift.

However, if the donor dies less than 7 years after making the gift, IHT then becomes chargeable at 40%.

Death Estate

If you leave the asset as part of your death estate rather than selling it or gifting it, IHT may be payable at 40%.

Items left to your spouse/civil partner/charity are exempt from IHT.

The value of your remaining estate chargeable to IHT could be reduced with the use of business property relief.

Everybody has a nil rate band of £325,000 which also reduces the amount chargeable to IHT.

This £325,000 is reduced by the gross chargeable transfers of any gifts made within the 7 years before death.

If your spouse did not use all or some of their nil rate band on their death estate, the amount unused can be transferred to you in addition to your £325,000.

The remaining value is then subject to IHT at 40%.

If you would like to get in touch with us, please use the contact formbelow, visit our website www.egan.co.uk or call us on 01254 583515.

Inheritance Tax: Residence Nil Rate Band (RNRB)

At Egan Roberts Chartered Accountants & Financial Advisors we offer estate planning services including the related tax advice. It is important we now think carefully about the residence nil rate band (RNRB) when estate planning. Please read on if you would like to find out more.

What is the RNRB?

The RNRB was introduced in Finance Act 2015 and applies to deaths after 5 April 2017.

The basic nil rate band currently stands at £325,000 as it has since 6 April 2009 and will not change until 5 April 2021.

Rather than increase the £325k nil rate band to adjust for the effects of inflation and increases in house prices, the RNRB was announced.

The RNRB provides an additional nil rate amount when a person’s main residence is passed to their direct descendant on death.

It is worth noting here that the RNRB is only available on death; it cannot apply to a lifetime gift.

How much is the RNRB?

The RNRB is in addition to the basic nil rate band (£325k) and will be gradually introduced as follows:

Tax Year      RNRB
2017/18    £100,000
2018/19    £125,000
2019/20    £150,000
2020/21    £175,000

After 6 April 2021 the RNRB will increase annually in line with the consumer price index.

When is the RNRB available?

The RNRB is available when a qualifying residential interest is closely inherited.

A qualifying residential interest is a residential property which at some point was occupied by the deceased as their residence.

It will be closely inherited if it is passed to any of the following:
• The deceased’s children or grandchildren and their spouses
• Widowers of those children/grandchildren if they have not remarried
• Step-children, adopted or foster children
• Children for whom the deceased acted as guardian whilst they were under 18 years old

Other information

In the same way as the basic nil rate band, if a person does not use their RNRB in full, any unused percentage can be transferred to the surviving spouse to be used in addition to their own RNRB.

The RNRB will be reduced by £1 for every £2 by which the deceased’s net estate exceeds a threshold of £2m. This threshold will also increase in line with the consumer price index.

As many people move into a smaller home or into residential care, the RNRB is still available on the estate if the person sold their home on or after 8 July 2015.

We hope you found the above information useful. If you would like to discuss estate planning or inheritance tax further, please contact Egan Roberts on 01254 583515.

Further guidance and information is available at https://www.gov.uk/guidance/inheritance-tax-residence-nil-rate-band