New Pension Rules Open Back Door To Avoid IHT

Lisa Smith, BA (Hons), CeFA

Scrapping the 55% death tax on unspent pension cash has opened the door on a new way to avoid inheritance tax for the wealthy.

Chancellor George Osborne’s announcement should be welcomed by anyone stuck in a tax trap because their estate is valued over the £325,000 inheritance tax threshold.

Instead of elaborate estate planning or accepting a 40% tax charge on their estate, pensions are a new way of passing on wealth without paying tax.

The move is also a clever ploy by the Tories who have made an election promise to increase the inheritance tax (IHT) threshold to £1 million if they win the next election.

Prime Minister made the pledge in the last Tory election manifesto but saw his plan derailed by the Lib Dems as a trade-off for making the coalition work.

His promise comes with a condition – that if the Tories fail to win an absolute majority in the House of Commons, he may have to horse trade the plan again to satisfy a new coalition partner.

How the rules work

In general terms, scrapping the 55% tax charge on unspent pensions means retirement savers can stack their pensions with cash subject to the £1.25 million lifetime allowance and £40,000 a year contribution limit.

It also gives a tax planning opportunity to avoid IHT should the next election result in another hung Parliament.

The key points to remember are:

  • The new rules only apply to defined contribution pensions – not defined benefit schemes, which include most public or civil service pensions. Defined contribution schemes include personal pensions and self-invested personal pensions (SiPPS)
  • If someone with untouched cash in a defined contribution pension dies before their 75th birthday, those inheriting the money will pay no tax until they drawdown the cash –spouses and dependent children under 23 are already exempt from tax.
  • When someone over 75 dies, the 55% tax charge is removed

No inheritance tax is paid on the transfer of the cash, but the people receiving the money will pay tax at their marginal rate if the draw down on the fund.

Pensions avoid IHT

Effectively, they are in the same tax position as the pension holder.

Accepted estate planning for someone already with enough savings to fund their retirement but facing a 40% inheritance charge was to start gifting assets and hope that they outlived the gift by seven years to nullify tax.

It seemed pointless putting the money into a pension because the tax charge was 15% higher than paying inheritance tax at 40%.

Providing the Chancellor keeps to his statement in the next Budget, conventional advice is now reversed and cleverly, that £1 million tax-free inheritance exemption is now £1.25 million and can be accessed through a pension.

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