Official data shows that more Inheritance Tax (IHT) was paid in the year leading up to April 2022 than in the previous 12 months. According to official government statistics, the Treasury received around £6 billion in the 2021/22 tax year, with record-high receipts in March 2022

One reason for this is likely to be the chancellor’s decision to freeze the nil-rate band (NRB) until 2026. The NRB is the amount your client can have in their estate on death before IHT is charged.

If their investments and assets increase in value during the NRB freeze, they could face an increased liability, which is why it’s important to take steps to reduce or negate any exposure to the tax. One effective yet little known way your client could do this is to leave loved ones their pensions.

Read on to discover how IHT is typically charged, and why leaving a pension could be a clever way to pass wealth to loved ones IHT-free.

Inheritance Tax is typically charged on worldly belongings

As IHT is usually charged at 40% on assets your client has above the nil-rate band (NRB), it has the potential to significantly reduce the amount your client leaves to family and friends.

The good news is that, in 2022/23, the NRB might allow your client to leave up to £1 million to beneficiaries IHT-free, depending on their circumstances.

If your client has an IHT liability, gifts would typically be used to deal with it. This is because HM Revenue & Customs (HMRC) allow several gifts to be made every tax year, which can help lower the value of your client’s estate, and in turn lower any liability to IHT.

If you would like to learn more about using gifts to reduce or negate an IHT liability, read our blog.

While gifting can be extremely effective, your client may also be able to pass their retirement fund on to beneficiaries without it being liable to IHT. Let’s consider this now.

Different pensions are treated differently for IHT

Pensions are not typically included in an estate for IHT purposes. That said, care needs to be taken as private and workplace pensions are usually treated differently.

If your client has a defined benefit (DB) pension, also known as a “final salary” scheme, when they die an income will usually be paid to their spouse or civil partner.

This is different to a defined contribution (DC) pension, which is also known as a “money purchase” scheme. If your client has a DC pension, it can typically be passed to a beneficiary without being liable to IHT.

If your client has already accessed their DC pension, any lump sum they have taken from it or any annuity they have purchased could fall back into their estate for IHT purposes. It is only the proportion of your client’s pension that has not been taken and remains invested that is unlikely to be liable to the tax.

Beneficiaries may receive the pension tax-free

If your client dies before the age of 75, the beneficiary will normally receive the pension pot completely tax-free, allowing them to take the money as a lump sum or as an income. To do this the pension needs to be claimed within two years of your client’s death, and if it is not, the beneficiary may then have to pay tax on it.

If your client dies after the age of 75, beneficiaries normally pay Income Tax at their marginal rate when they receive the pension.

Pensions can be a clever way to mitigate an IHT liability

Not accessing a pension pot and instead leaving it to loved ones could be a clever way to pass wealth IHT-free. For that reason, your client may want to consider living off savings and other assets before accessing their pension pot.

As well as preserving the pension, it might also allow it to grow in value, meaning your client could potentially leave more money to beneficiaries.

Get in touch

While preserving your client’s pension could be a shrewd financial move, care needs to be taken to ensure it’s not at the expense of their standard of living in retirement.

Speaking with a financial planner could confirm whether using their pension to help reduce or negate an IHT liability is right for your client.

If you would like to discuss this further, please contact hello@ardentuk.com or call 01904 655 330. As an award-winning financial advice company that was a 2022 VouchedFor Top Rated firm, you’ll have peace of mind that any client who deals with us will be in safe hands.

Please note

This article is for information only. 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. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.