In our weekly series, readers can email in with any question about retirement and pension saving to be answered by our expert, Tom Selby, director of public policy at investment platform AJ Bell. There is nothing he doesn’t know about pensions. If you have a question for him, email us at money@inews.co.uk.
Question: I’m a high earner in my early sixties and a higher-rate taxpayer. I’ve got a large company defined contribution pension which I’ll start taking soon, but am unlikely to need to whole of in my lifetime. If I want to transfer some of this to my children, what’s the best way to do this, now my pension is subject to inheritance tax?
Answer: Firstly, pensions are not yet subject to inheritance tax (IHT). The Government has, however, said it intends to bring unspent pension pots into the IHT net from April 2027, although the details of how this will work have not yet been finalised.
It is important not to make any rushed decisions about your retirement pot ahead of this deadline, as up until April 2027 it will still be possible to pass your pension to your nominated beneficiaries without paying IHT. In fact, if you are unfortunate enough to die before age 75, your pension could be inherited completely tax free.
From 2027 onwards, any decision about your pension linked to minimising your beneficiaries’ IHT bills needs to be carefully considered, ideally with the help of a regulated financial adviser who can talk through your options based on your personal circumstances.
IHT should only be a factor for those planning to pass money on to someone who isn’t their spouse or civil partner, as transfers to either will remain IHT free – including when pensions are brought into IHT from 2027.
In addition, where someone is planning to pass money onto other nominated beneficiaries, an IHT charge of 40 per cent will only become an issue once what is known as your nil-rate bands have been exhausted.
These bands are the value of the assets you can pass on without attracting any IHT charge.
In the current tax year, the main IHT nil-rate band is £325,000 per person, while there is an additional £175,000 nil-rate band that applies to your main residence if passed on to a direct descendant and your estate is below £2m.
Under the proposals outlined by Chancellor Rachel Reeves in her Budget in October, pension pots that have not yet been spent will count towards IHT when you die. That means where a beneficiary who is not a spouse or civil partner inherits your pension over-and-above your nil-rate bands, it will be taxed at 40 per cent.
Furthermore, where the person who dies is over age 75, the money will also be subject to income tax, meaning a higher-rate taxpayer beneficiary could effectively face a tax charge of 64 per cent on money left to them.
While this might cause some immediate alarm, you need to think carefully about any decisions you make with the aim of reducing your potential IHT bill. As I mentioned at the beginning, the change won’t take effect until April 2027 and it isn’t yet clear how this will be applied. If you take money out of your pension today and then die before April 2027, your beneficiaries may face IHT charges that could otherwise be avoided.
If you are considering taking money out of your pension to try to minimise your beneficiaries’ overall IHT bill – for example by taking advantage of gifting allowances – make sure you are crystal clear about the consequences.
Taking large withdrawals from your defined contribution pension could result in you paying more income tax than is necessary. Accessing taxable income flexibly from a self-invested personal pension for the first time will also trigger the “money purchase annual allowance”, reducing the amount you can contribute tax-free to defined contribution pensions each year from £60,000 to £10,000.