Pensions are a ‘valuable tool’ to reduce inheritance tax burden

While frozen inheritance tax (IHT) thresholds continue to place a heavy burden on families, many have been searching for ways to plan better, reduce the bill and give more to loved ones.

People may be unaware that their pension can be a tax-efficient way to pass on wealth, but there are rules.

Paul Barham, partner at Mazars commented: “Individuals can take steps to mitigate their IHT liability, all it takes is some planning. Personal gift allowances, using clear expression of wish documents and even having a valid Will in place are often overlooked IHT planning tools.”

Mr Barham continued: “Pensions can be a valuable tool when passing down wealth because they sit outside your estate for IHT purposes.”

He explained that as of April 2023, the lifetime allowance (the total amount a person could build up in pension savings without incurring a tax charge) was removed, meaning “there is no limit on how much you can save over your lifetime”.

He added: “If you have assets inside and out of a pension plan, you’ll want to consider when to draw down from your pension and whether to also consider using non-pension assets to meet the full cost of everyday life.”

However, Emma Watson, head of financial planning at Rathbones Group Plc warned that while assets in pensions are usually exempt from IHT: “To make sure they are not paid into your estate and taxed, you should check with your pension provider that you have a nominated beneficiary in place.”

People can also contribute to a family member’s pension, which can come with its own tax benefits.

Liz Hunter, director at Money Expert told : “You can also contribute to a family member’s pension. The recipient would maintain their pension allowance of 100 percent of their earnings, or £3,600 if they have no earnings.

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“This means that as long as their pension contribution remains below this allowance, you can donate as much as you like. The pension holder can then claim a 20 percent tax rebate and could possibly claim the rest through a self-assessment tax return.”

What is the current inheritance tax rate?

Inheritance tax is charged on a person’s estate if the total value of assets exceeds £325,000. This is the current tax-free threshold, referred to as the nil-rate band, for the 2023-24 financial year.

The amount above this threshold could be subject to an inheritance tax rate of 40 percent, unless left to a spouse, civil partner or a charity, in which case the rules change again.

Ms Watson added: “Everything below this amount is not liable to IHT, however certain gifts, if not covered by the available allowances, may reduce the amount of nil rate band available on your death.

“In addition, if you leave your family home to your children or grandchildren, an extra nil rate band of up to £175,000 may also be available meaning more of your estate can be passed on tax-free (although this is reduced for estate values over £2million).”

People can read more about inheritance tax rules here.

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