What can you do about inheritance tax?
Thanks to property price inflation and frozen tax thresholds, inheritance tax has gone from something to worry only the landed gentry to something that will affect almost every family.
Inheritance tax is punitive for our loved ones. The taxman is waiting to help himself to 40% of everything we leave above £325,000, with an additional £175,000 allowance if our main residence is passed to direct descendants.
Naturally, having paid tax on every pound we earned when we are alive, we resent the taxman taking a second helping when we die, depriving our nearest and dearest of the fruits of our labours.
Equally naturally, we try and find ways to reduce our tax burden. Until recently, the simplest solution was to put as much of our wealth as we could spare into our pensions, which could often be passed on tax-free.
Unfortunately, Chancellor Rachel Reeves put a stop to this loophole. In last year’s autumn statement, she announced that from April 2027, most pensions and death benefits will count towards your estate for inheritance tax. The taxman will be taking an extra slice of your wealth with a share of your unspent pension pot.
The temptation to take an annuity just to spite him is strong. Once your pension pot is used to buy an annuity he can no longer touch it. But while popular with the insurance companies who provide annuities, this does nothing for your beneficiaries.
You need to rethink your succession strategy – the techniques you adopt to redirect your wealth away from the taxman. And there is another way you could use a pension to beat inheritance tax.
But not your own.
Building a children’s pension
Although we usually wait until we are earning for ourselves, anyone can save into a pension at any age. Pensions for children can be set up from birth by a parent or legal guardian, though anyone including grandparents or family friends can contribute. They have some powerful advantages.
One of the most appealing is children’s pension tax relief, meaning that the taxman will contribute with you. Contributions up to £2,880 per year are eligible for 20% tax relief, meaning the government tops it up to £3,600—even if the child has no income.
Starting early allows decades of tax-free investment growth, making even small contributions potentially powerful. Looking at £3,600 of contributions a year from birth to 18 (the maximum £2,880 allowed with tax relief added) at a conservative 5% interest in a Junior SIPP (Self-Invested Personal Pension) could be worth around £106,000 by the time they reach 18.
Setting up a child’s pension means years of compound growth working for your family, not the Treasury.
Leave that invested with no further contributions and, by the time they are 66, that pot might be worth more than £1 million. This is a very rewarding return on total contributions of £51,840.
But that’s not the end of the benefits. The £51,840 is removed from your estate, meaning the taxman cannot take a 40% slice of it.
This is even better than it might first appear. A gift can still be counted as part of your estate for tax purposes if you die within 7 years of giving it, to prevent the taxman being frustrated by ‘deathbed giving’. However, if you make regular gifts from ‘surplus income’, that is, not from your capital savings, the 7-year rule will not apply.
This means that if you set up a child’s pension properly, you can use it to reduce your taxable estate as well as give your child a big financial boost for life. If you have already retired, you can even use it to pay down your pension savings, getting them away from the taxman’s reach.
Getting some help
Of course, setting up a pension, setting up regular payments that will escape the taxman’s grip and ensuring that you own retirement remains secure will take some expert knowledge. There are things that can go wrong, and when they do, it can be expensive.
Fortunately, the help you need is easy to get. Simply call us at Continuum, and get our expertise working for you.
Future Value Calculator | AllCalculators.co.uk
Junior SIPP calculator | Hargreaves Lansdown
Inheritance Tax on pensions: liability, reporting and payment — Summary of responses – GOV.UK
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment, retirement or taxation strategy, you should seek independent financial advice before embarking on any course of action.
The Financial Conduct Authority does not regulate taxation and trust advice or will writing.
A pension is a long-term investment; the fund value can go down as well as up and this can impact the level of pension benefits available. Pension Income could also be affected by interest rates at the time benefits are taken. Pension savings are at risk of being eroded by inflation
Levels and basis of reliefs from taxation are subject to change and their value depends upon your personal circumstances. We recommend that the investor seeks professional advice on personal taxation matters.
