Pensions and IHT – could you now save more tax?

Recently, we blogged about the recent Budget pension changes and how you could make the most of them. With regard to the latter, we focused on how the changes now give you the opportunity to extract more money from a limited company free of tax. However, there’s one other big saving the new rules on pensions offer you: Inheritance Tax (IHT). In this post, we look at pensions and IHT and how you may be able to protect more of your money from the latter.

A recap of the pension changes

The two key changes were to the pensions lifetime allowance and the annual allowance.

Before the Budget, you were allowed to save up to £1,073,100 into your pension pot tax-free. Anything you saved above that figure was liable to 55% tax.

In addition, you used to be allowed to put £40,000 per year into your pension without paying tax. This has now gone up to £60,000. In addition, any money you pay in under this amount attracts tax relief. For a basic rate taxpayer, HMRC essentially adds £25 for every £100 you put in.

Pensions and IHT

You generally have to pay IHT if:

• Your estate is worth more than £325,000 (spouses and civil partners can pass on their allowance, giving the surviving partner a threshold of £650,000)

There are also other rules that can increase the IHT personal allowance. For example, if you leave your home to your children or grandchildren, something called the Residence Nil Rate Band (RNRB) can bump up your allowance as much as £175,000.

We have published a fuller guide to Inheritance Tax planning, which talks you through more of the complexities. However, the thing to keep in mind is that people who have large pension pots (and can afford to put more in them each year) are more likely to have estates that fall within the scope of Inheritance Tax.

How the new rules affect pensions and IHT

The great thing about pensions is that, if you pass on your pension pot after you die, Inheritance Tax doesn’t usually apply to it. This is because your pension is not considered to be part of your taxable estate.

Until the recent Budget changes, anything over £1,073,100 that you put into your pension pot attracted tax at 55%. This contrasted unfavourable with the 40% rate payable for IHT.

However, now there is no limit to the sum you can put into your pot tax-free, many experts are looking at whether putting more cash into pensions has tax advantages. In this article in the i newspaper, one financial planner is quoted as saying:

“…if people have saved or plan to save large amounts in their pension, they can continue to reap the benefit of tax relief on the pension contributions and now amass a bigger pot because of the scrap of the lifetime allowance, pass this on to their children or spouses without incurring any Inheritance Tax.”

The message is clear. If you are able to, put the new maximum of £60,000 tax-free into your pension each year. By doing so, you’ll be able to put more money outside the scope of IHT.

Some words of warning

While stashing extra money in your pension in this way makes sense, there are a few things you need to bear in mind. In the same article we’ve just quoted, another expert said we need certainty about the new pension rules and – crucially – an assurance they won’t change again. If the rules did change again, you could find your pension pot attracting tax above a certain amount.

The second thing to bear in mind is that you need a pension that can be passed on. Not all pensions can be. We’ve written an article about the options you have for passing on pensions, but it’s vital you speak to a pensions expert.

Finally, it’s worth remembering that, if you take money out of your pension, then it becomes part of your estate again. This means it could attract IHT.

What next?

On the face of it, the new pension rules look like they could be a game-changer for estate planning. Given this, now is a good time to review your pensions. An independent pensions expert can advise on how to pass pensions on tax efficiently. Finally, if you need help drafting or updating your Will or setting up a Lasting Power of Attorney, get in touch today. We’d be delighted to help.