02 Oct 2020

Pensions and Inheritance Tax planning

Christian Feroze

Associate Financial Planning Director

What happens to your pensions when you pass away and who can benefit?

Many of the clients we speak to are concerned about the effect Inheritance Tax (IHT) will have on the wealth they can pass on to their loved ones. It’s a complex topic, with different solutions for each client, but one element we always consider is a client’s pension savings and other sources of income.

IHT planning in action

We were recently referred to a client who wanted some help understanding IHT laws, to ensure their loved ones received as much of their estate as possible when they passed away.

 

The client and his wife were in their late 60s, with their three children living across the UK. They were looking forward to gradually slowing down from running their business but needed some advice to feel confident about what would be the best way forward for their circumstances.

 

To support their retirement, they had a property portfolio generating a rental income, their business, several ISAs, and the husband’s pension savings, totalling £900,000.

 

Owing to the property portfolio and investments they had an IHT liability as well as capital gains issues.

Misconceptions about pensions and IHT

The client felt strongly that they would use their pensions as primary source of income in retirement, as they were fearful the pot would pass away with them on death (as had happened to their parents, who had purchased an annuity but died at a relatively young age). They wanted to withdraw the pension income and save any excess withdrawals into ISAs each year.

 

This would seem sensible, that given pensions are seen as the ‘nest egg’ for retirement, but by following this path the client would have been paying higher rate 40% income tax on the pension income and rental income while, at the same time, increasing their estate liable to 40% IHT on second death (not to mention reducing the availability of the residents nil rate band - but we can save that for another day).

The interaction of Pensions and IHT

It is often overlooked that pensions are written in trust and are therefore usually outside of the estate for IHT purposes. Moreover, since the introduction of flexi-access drawdown in 2015, you no longer have to purchase an annuity and can leave the benefits invested for any beneficiary for your lifetime.

 

When you pass away, your benefits may be distributed according to your death benefit nomination form and can be distributed to anyone, it is also worth remembering that if you pass away pre 75, the beneficiary can access the monies as income or a lump sum completely tax free (after 75 the beneficiary will be liable to tax on withdrawals).

 

It can feel counterintuitive, but we are now recommending that certain clients preserve pensions and live off other sources of income in retirement, which for this client meant living off the rental and ISA income, leaving the pensions to grow tax free.

 

By following this path, the client would reduce the value of the estate by spending the ISAs, while nominating the three children to receive the pension in equal share on his death, bypassing his wife who did not need the capital.

The importance of IHT planning

There are so many flexibilities and freedoms with pensions these days but any decision needs due diligence and care, particularly if lifetime allowance issues are involved. Circumstances and plans change (not to mention legislation!!), which is why we work closely with our clients on an ongoing basis to adjust their personal finances and income strategies to meet their changing circumstances.

Find out more

Whether you are looking to invest for the first time, or have an investment portfolio already, if you don’t know where to begin, or know exactly what you are looking for, we can help. Contact your local Investec experts in Cheltenham today, to discover how we can help you to fulfil your financial goals, and live life the way you want to.