Inheritance Tax (IHT) is often a significant concern when planning for the future of your loved ones. Fortunately, pensions can offer an effective and valuable solution, as they can be passed to beneficiaries free of IHT in many cases. In this blog, we will explore the role of pensions in estate planning and discuss the conditions under which they can be passed on IHT-free.

Understanding Inheritance Tax (IHT)

Inheritance Tax is a tax levied on the estate of an individual who has passed away. The estate includes assets such as property, possessions, and money. In the UK, the IHT threshold is £325,000 per individual (and potentially an additional £175,000 for your private residence) any amount exceeding this is subject to a 40% tax rate. However, the tax landscape becomes more favourable when it comes to passing on pensions.

Pensions and IHT: A Valuable Tax Shelter

Pensions serve as a powerful tax-efficient tool in estate planning. Unlike other assets, pensions are generally outside the scope of IHT. When a pension holder dies, their pension funds can be passed on to their chosen beneficiaries without incurring IHT, provided certain conditions are met.

Conditions for IHT-Free Pension Transfers

1. Age of the pension holder: If the pension holder dies before the age of 75, their pension can be passed on to their beneficiaries tax-free, regardless of whether they have accessed the funds or not. However, if the pension holder dies at or after the age of 75, the beneficiaries will have to pay income tax on the pension received (but still no Inheritance tax) at their respective marginal tax rates.
2. Defined Contribution Pensions: The tax-free pension transfer is typically applicable to Defined Contribution (DC) pensions, also known as money purchase schemes. In these pensions, the individual and their employer make contributions to a personal pension fund that is invested. The final pension amount depends on the investment performance. On the other hand, Defined Benefit (DB) pensions, which provide a guaranteed income based on an employee’s salary and years of service, are generally not passed on to beneficiaries IHT-free.
3. Nomination of beneficiaries: For pension funds to be passed on IHT-free, the pension holder must have nominated their beneficiaries. This nomination can be done through a nomination form provided by the pension provider. It is crucial to ensure the pension provider has up-to-date details of the intended beneficiaries to avoid complications during the transfer process.
4. Flexi-Access Drawdown: Pension funds can be transferred to a beneficiary in a tax-efficient manner through Flexi-Access Drawdown. This allows the beneficiary to keep the pension funds invested and withdraw money as needed. If the pension holder dies before the age of 75, the beneficiary can withdraw the funds tax-free. If the pension holder dies at or after the age of 75, the beneficiary will pay income tax on withdrawals at their marginal tax rate.

Conclusion

In conclusion, pensions can offer a valuable IHT-free solution when planning for your loved ones’ financial future. To maximise the benefits of pension wealth, it is crucial to understand the conditions under which pension funds can be passed on IHT-free. Ensure that you have nominated your beneficiaries explore options such as Flexi-Access Drawdown to optimise the tax efficiency of your estate.

As with any complex financial matter, it is always advisable to consult with a financial advisor or expert to discuss your individual circumstances and ensure that your estate planning aligns with your financial goals and objectives. By taking a proactive approach to estate planning and understanding the role of pensions in IHT planning, you can help secure your loved ones’ financial well-being for years to come. At Kudos we are here to help should you need any advice.