Today we come to one of the most potentially useful tools in inheritance tax planning – the humble pension.
Most people know that private pensions are very tax efficient. However, their inheritance tax advantages are less recognized. That’s a shame – the fact that your retirement assets don’t go into your estate for inheritance tax purposes means it can be a great way to pass money on to heirs and even reduce a potential tax burden.
The bottom line is that in the event of death, pension pots are not subject to inheritance tax – they do not count towards your estate. However, not all retirement savings can be passed on to the heirs.
If you have a defined benefit or final salary pension where your employer guarantees a certain pension when you retire, you do not have to leave a savings fund; Your heirs may receive benefits such as alimony, but they will not inherit any of your savings.
In contrast, defined contribution or commercial pension schemes can be passed on under certain conditions. This includes savings that you have made as part of a company defined contribution pension system and savings in individual plans such as self-made private pensions (Sipps) or pensions for interest representatives.
How an Annuity Can Help You With Estate Planning
With a defined contribution plan, you have a choice after you reach retirement age and start earning income. With the pension fund you have saved up, you can buy an annuity – which guarantees a lifelong annuity – or you can opt for an income deduction scheme in which you can keep your fund invested and receive income directly from it. (Or you can do a little bit of both).
The money you spent on an annuity is gone forever (however, you can get a dependents’ benefit contract). However, unused savings can be passed on to the heirs in an income deduction scheme. Your contribution-based pension fund can also do this if you still have to decide between a pension and a claim.
Either way, if you die before the age of 75, the person who inherits your savings pays no inheritance tax and can also withdraw the money free of income tax. If you die after 75, your heirs will still not pay inheritance tax, but income tax will be charged on withdrawals.
The exemption of pensions from inheritance tax gives rise to several design options. Obviously, it can make sense to prioritize retirement plans for your future savings if your non-pension assets (e.g. you may even be able to move existing savings and investments to your pension fund to take them out of the inheritance tax net).
Even if you retire with considerable savings and investments outside of your pension plan, it can make sense to take advantage of these before paying into your pension fund. This way, you will reduce your estate for inheritance tax purposes before you use up any savings that do not fall into your estate.
Be aware of the risks
However, it is important to look at inheritance tax in the context of your general needs and circumstances. For example, too high a contribution to the pension can cause tax headaches, as there are strict limits to how much you can invest in the pension annually and for life in a tax-efficient manner (so-called lifetime allowance). Tax limit, which is unlikely to increase in the next few years).
Similarly, while income reduction plans make it easy to leave savings to heirs, you need to carefully manage them to make sure you have enough income to live on and that your money lasts for as long as you need it.
It therefore makes sense for most people to seek professional advice on how to plan your retirement provision from all angles, including possible inheritance tax debts.
This is definitely true if you are considering transferring money from a defined benefit pension scheme. Some people are so eager to pass their retirement savings on to an heir that they are willing to forego a guaranteed pension in a defined benefit system – even if that means they themselves will receive less pension income from a defined contribution system.
This is not a step taken lightly. Financial regulators advise against such transfers in most cases, and there is a legal requirement to seek professional advice when transferring funds in excess of £ 30,000.
In most cases it is far better for individuals to stick to the merit system.
One last point. Since your pension is not legally part of your estate, it is not covered by your will. Therefore, you have to agree separately with your pension provider who you would like to inherit. As a rule, you have to fill out a form – this can be referred to as a “request” or “beneficiary proposal” form or something similar.
Make sure that you keep the paperwork up to date as your life circumstances change – and that you have made provision for each of your retirement pots if you have different plans.