A shift in inheritance rules that has accompanied pension freedoms has led to wealthy investors considering a U-turn in the way they hold or spend assets.
Since April 6, 2015, many wealthy pension savers may are better off keeping their retirement assets locked away while drawing down on other assets, like shares, ISAs and cash savings.
This was previously frowned on by many investors due to the massive tax consequences of leaving cash in pensions.
On April 6, the government stripped away these punitive 55% inheritance tax charges on unused pension funds – and in the face of conventional wisdom that was valid up to the day before, suddenly pensions have become one of the most tax efficient places to keep money.
As well, pension contribution relief and tax free fund growth are big attractions, even though income tax levied on drawdown dilutes some of the benefits.
Change of tack
Before pension freedom day, many wealthy investors were advised to drawdown and spend their pensions while keeping cash in ISAs intact.
Now, that advice has turned on its head and investors are told to keep their pensions intact and spend any other savings that will increase the value of their estate for inheritance tax.
The current inheritance tax threshold is £325,000 for an individual, but this can be doubled up for married couples or civil partners if the spouse who dies first passes their threshold to the surviving spouse.
As IHT is paid on ISAs and cash savings that breach the threshold, but pension savings are now exempt, it makes sense to spend cash savings and other investments before a pension.
Nil rate band
Tax is paid at 40% on any estate exceeding the inheritance tax threshold.
This changes the possibilities for pension planning considerably.
For instance, couples who save into ISAs to keep cash aside for long term care could see this money taxed at 40%, while a much larger pension fund escapes unscathed.
The Tories plan to give each spouse an extra £175,000 nil-rate band for the family home, taking their combined IHT exemption up to £1 million, so a family home can pass without tax to loved ones.
So shuffling assets to decide which to spend first to save tax is becoming an important part of estate planning – and any tinkering to inheritance tax by the next government could also make a big difference.
