Is your pension at risk of 40% Inheritance Tax? 4 smart strategies to shield your estate: in the spotlight

In the spotlight this month; with the recent announcements that pensions will form part of the estate, we cover what the changes mean to you, and how to plan for them.

Inheritance Tax (IHT) is often called a "voluntary tax" – not because it’s optional, but because with careful planning, it can be completely mitigated.

For those with estates likely to exceed the tax-free threshold, knowing the rules and planning is crucial.

Here's a comprehensive look at the basics, recent changes, and strategies you can consider.

Inheritance Tax: the basics

IHT is charged at 40% on the value of your estate above a certain threshold when you die. Currently, the nil-rate band is £325,000 per person. If you leave your home to your direct descendants, an additional residence nil-rate band of £175,000 may apply, potentially raising the total allowance to £500,000 per person (£1 million for a couple).

Anything above these thresholds may be taxed unless reliefs or exemptions apply. It’s important to remember that your “estate” includes not just property, but savings, investments, and possessions.

Budget changes

The Autumn Budget 2024 brought some changes to light. From 6 April 2027, pensions will be included in the estate for IHT purposes. This has presented many people with a gap in the inheritance tax mitigation plans.

Currently, it is unclear how this change is going to be implemented; we will have more clarity on this once the conclusions from the January consultation period is made public.

What happens if you die at 75?

Reaching the age of 75 is a key threshold in estate planning. Why? Because pension tax rules change.

Currently, if you died before age 75, unused pension pots can usually be passed on tax-free. However, passing away after 75, your beneficiaries pay income tax on inherited pensions.

Passing away after 75 coupled with pensions forming part of your estate from April 2027 could lead to a considerable amount of tax being paid!

Let’s look at four key solutions to help mitigate IHT.

1. Spend it

One of the simplest ways to reduce your taxable estate is to enjoy it. Sensible spending on holidays, home improvements, or gifts can lower the value of your estate. This however will not be a full solution for most people.

2. Insure it

A common and effective IHT planning tool is using a life insurance policy written into trust.

How it works:

• You take out a life policy equivalent to your expected IHT bill, or part of it

• The policy is written into trust, so it's outside your estate

• When you die, the proceeds can be used to pay the tax, preserving the estate for your beneficiaries.

Advantages:

• Quick access to cash for tax bills

• Preserves family wealth

• Simple solution.

Considerations:

• Premiums rise with age – better to do this sooner rather than later when premiums will be higher

• Must be structured correctly, or the payout may fall into your estate.

3. Gifting

Gifting is one of the most popular ways to mitigate IHT.

Key gifting options:

• Annual exemption: You can give away £3,000 each year free of IHT

• Small gifts: Up to £250 per person per year

• Gifts from income: Regular gifts out of surplus income can be exempt

• Potentially Exempt Transfers (PETs): Larger gifts fall outside your estate if you live for seven years after giving

• Gifting into trusts: there are different types of trusts you can gift into, some providing the option for income or flexibility to take your money out.

Advantages:

• Straightforward and well-established rules

• Can see loved ones benefit during your lifetime.

Considerations:

• PETs may be subject to taper relief if you die within 7 years

• Giving too much too soon may leave you financially exposed.

4. Business Relief

Business Relief (BR) is a powerful yet often overlooked IHT planning tool. If qualifying shares are held for two years, you can benefit from 50% or 100% relief from IHT dependent on the amount invested. The investor also retains ownership of the investment, retaining access if they did need it.

Current rules mean that you should benefit from 100% IHT relief on the first £1m of BR investment, and 50% IHT relief thereafter.

Packaged Products available that offer no IHT from 2 years on, and some that offer relief from day one!

Advantages:

• Significantly reduces IHT exposure

• Allows continued growth of capital in certain cases.

Considerations:

• Investments can be high-risk and illiquid

• Complex rules – advice is essential.

Final thoughts

Inheritance Tax can be an avoidable tax – but only with the right advice and timely action. Whether it's through insurance, gifting, or strategic investment, there are numerous ways we would be able to help you reduce your family's exposure to IHT.

As with all financial matters, especially those involving large sums or complex rules, speaking with one of our qualified financial planners is crucial. Let us help you build a tailored estate plan that reflects your goals, protects your family, and makes the most of your wealth.

Contact us today for a personalised inheritance tax consultation.

Email info@mlpwealth.co.uk or call us on 020 8296 1799.

For more information regarding this article, see our recent webinar on the topic by following this link to YouTube.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All information is correct at the time of writing and is subject to change in the future.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.