In his Spring Budget back in March, the chancellor froze the Inheritance Tax (IHT) nil-rate and residence nil-rate band until at least 2026.
A response to the economy’s slow recovery from the coronavirus pandemic, the move is expected to raise nearly £985 million for the Treasury. During the next five years, rising house prices and investment growth will see the number of people leaving an IHT liability on death rise.
With other tax and threshold freezes in force – the Lifetime Allowance, the Capital Gains Tax allowance, and the Personal Allowance – managing your wealth tax-efficiently is set to become an even trickier juggling act.
You’ll need to balance pension and investment growth with ensuring you have sufficient retirement income and leaving enough for an inheritance (if you intend to leave one). You’ll also need to consider the potential cost of later-life care.
One way to manage your estate planning might be to hold off on taking your pensions if you can afford to.
Keep reading to find out why this might help and the difference it could make.
Unused pension funds remain outside of your estate for IHT purposes
Under current rules, your pension usually sits outside of your estate for IHT calculations. This means that holding money in your pension is a great way to manage the value of your estate. It also means that you can pass on pension wealth tax-efficiently, and – in some cases – completely tax-free.
The way you pass on your pension wealth will depend on various factors, including your age when you die, whether you have started to draw benefits, and if so, how you have chosen to access these funds.
Let’s take a closer look at these three factors:
1. How and when did I take pension benefits?
Once you fully access your pension, either by purchasing an annuity or taking a full lump sum, the pension is treated as part of your estate. Drawdown, however, leaves a proportion of your pension invested and this amount remains outside of your estate.
You might reach retirement age without having a financial need to take your pension; maybe you are still working full-time, or have a regular income from buy-to-let properties, for example? Leaving your pension untouched will mean it remains outside of your estate.
Equally, if you have more than one pension plan, you might start taking funds from one or two of them, while leaving a third untouched and earmarked for an inheritance.
Holding off taking pensions, if you can afford it, could be incredibly tax-efficient.
2. What if I die before age 75?
On death before age 75, unused pension funds can be passed to a chosen beneficiary tax-free.
You must nominate your beneficiary via an Expression of Wish form and be sure it is kept up-to-date so that it is always an accurate reflection of your wishes.
Your beneficiary can take the funds as a lump sum, via drawdown, or through an annuity. They must claim within two years of your death; otherwise, tax may become payable.
The above applies to the defined contribution (DC) plans you hold. The rules for defined benefit (DB) schemes largely depend on whether you retired before you died. If you die before you retire, and before age 75, the pension will usually pay out a lump sum based on your salary.
3. What if I die after age 75?
If you die after age 75, your unused pensions can still be passed to a beneficiary, but there will be tax to pay at their marginal rate. As with death before age 75, your beneficiary can take funds as a lump sum, through drawdown, or via an annuity.
For DB funds – and where you are already retired – the pension will usually continue to pay at the same, or a reduced amount, to your spouse, civil partner or another dependent.
Although you can nominate a beneficiary, the scheme rules may state who can and can’t receive your pension on death.
Leaving your pension until last has other benefits too
The most obvious reason to hold off on taking your pension is that you’ll continue to benefit from investment and compound growth.
It’s also worth considering your life expectancy. As UK life expectancies rise, your pension may need to last for 30 years or more. If you have investments or funds from elsewhere, you might find that added growth makes pension budgeting easier, allowing you to enjoy your pension more when you do eventually take it.
Hartsfield Planning’s holistic approach to financial planning and retirement allows us to help you manage your income tax-efficiently, wherever that income comes from.
Get in touch
If you would like to discuss the IHT benefits of holding onto your pension or any other aspect of your long-term financial plans, please get in touch and find out how our team of expert planners can help.
Please note
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.