The way pensions are treated after you die is set to change, and this could have a direct effect on your beneficiaries’ inheritance.
From 6 April 2027, unused pensions will be included in your estate for the first time. This could mean your loved ones face an Inheritance Tax (IHT) bill or be liable for a larger payment than expected.
Understandably, you’re likely to want your hard-earned wealth to go to your chosen beneficiaries, rather than be eroded by a tax bill. As the date for the new legislation is fast approaching, putting some measures in place now could help to protect your wealth at the same time as boosting your children’s and grandchildren’s futures.
Read on to discover five ways you could reduce your IHT bill and pass more of your wealth on to the younger generations.
Frozen thresholds and new pension rules could see more estates fall into the scope of Inheritance Tax
Historically, pensions have remained outside an estate and not been in the scope of IHT. This has made them a relatively simple, tax-efficient way to pass wealth on to loved ones.
However, the new rules could require a significant change in mindset in order to offset any potential increase in IHT.
Acting now could help to protect your wealth. First, here’s a quick reminder of the IHT thresholds, which have been frozen until 2031.
- The nil-rate band is £325,000 and is the usual tax-free allowance for your estate.
- The residence nil-rate band is £175,000 and is an additional allowance if you leave your main home to your direct descendants.
- Combining these two thresholds can allow you to pass on up to £500,000 free from IHT.
- Spouses and civil partners can pass any unused allowances to the surviving partner, potentially giving you £1 million to pass on free from IHT as a couple.
- IHT is usually applied at 40%.
Another important consideration is the “double-tax trap”. If you die after the age of 75, your beneficiaries will be taxed on pension withdrawals at their marginal Income Tax rate. This could mean paying 40% in IHT, along with 20%, 40%, or 45% on withdrawals.
However, forewarned is forearmed, and making a few changes to your estate planning strategy could help to reduce your estate’s IHT liability.
1. Using your pension to fund your retirement
While you may have previously been advised to preserve your pension, the upcoming rule changes mean it could be more prudent to use pension income to fund your retirement, leaving more tax-efficient assets, such as ISAs, to your family.
Although these are included in your estate and could be subject to IHT, they could help you to avoid the double-tax trap.
2. Gifting during your lifetime
There are several ways you can gift your wealth while you’re still alive. Not only could this reduce your estate for IHT purposes, but it’s also a lovely way to help your family and see them benefit from your gifts.
Annual exemption
You can gift up to £3,000 a year free from IHT. If you have any unused allowance left from the previous year, this can be carried forward into the next year.
Potentially exempt transfers
Gifts above your annual exemption are typically considered potentially exempt transfers (PETs). If you live for seven years after making a PET, it will be exempt from IHT. If you die between three and seven years after making the gift, then IHT will be applied on a reduced sliding scale.
Gifting from surplus income
If you have excess income, you can make regular payments to your children without this being included in the scope of IHT. The gifts need to follow a regular pattern and not have a detrimental impact on your lifestyle.
This can be a good way to add to your children’s or grandchildren’s savings or pay school or university fees.
Small gifts
Another tax-efficient way to support your family during your lifetime is with small gifts. You can give up to £250 IHT-free to as many people as you choose each year (as long as they haven’t been the recipient of a larger gift), which can be useful for birthday and Christmas presents.
3. Junior ISA
Junior ISAs (JISAs) can only be opened by a parent or guardian, but anyone can pay into them. They work similarly to adult ISA products and are available as a Cash JISA or Stocks and Shares JISA. The money legally belongs to the child, but they can’t access it until they’re 18.
You can make use of your annual exemption, PETs or surplus gifting to make payments into a JISA, removing money from your estate and transferring wealth to your children or grandchildren.
4. Children’s pension
Saving for retirement isn’t just for grown-ups. A parent or guardian can open a pension for a child, which can be accessed from the normal minimum pension age (NMPA). This is currently 55 and is set to rise to 57 from April 2028. This can be a good way to support your family’s future, at the same time as reducing your estate.
5. Lifetime ISA
Lifetime ISAs (LISAs) can be opened by anyone aged between 18 and 39, and while you can’t make direct payments into them, you can pay your loved ones through the gifting options we’ve outlined above to add to their own LISA. They can pay up to £4,000 a year into a LISA, with the government then adding a 25% bonus. The money within a LISA can only be withdrawn to fund a first home or retirement, so you know you’re contributing to the next generation’s future.
Get in touch
The new rules mark a step change in the way pensions are managed after you die, and in turn could require a very different approach to your estate planning. We’re happy to help you create a financial strategy that works in line with your own circumstances, helping to pass on more of your hard-earned wealth to your loved ones.
Please get in touch by emailing hello@fingerprintfp.co.uk or calling 03452 100 100.
Please note
This article is for general information only and does not constitute advice. The information is aimed at individuals only.
All information is correct at the time of writing and is subject to change in the future. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
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.
The Financial Conduct Authority does not regulate estate planning.