Inherited Pensions and Inheritance Tax
In the lead up to today’s budget speculation was rife that pensions were in the chancellors’ crosshairs. Rumours of flat rates of income tax relief, reductions to the amount of tax-free cash that could be accessed and changes to employer’s pension contributions were all off target. You can still access 25% of your pension fund tax-free, capped at £268,275 in most cases and the state pension triple lock system lives to see another day.
However, ‘inherited pensions’ will be brought into the Inheritance tax (IHT) arena from April 2027, meaning unused pension funds and death benefits will be included in the value of an individual’s estate for IHT purposes.
This will not only have an impact upon how one plans to fund their retirement, but it will also have a significant effect on estate planning and how people intend to leave assets to loved ones, especially for those with larger pension pots and estates.
Currently in many cases it makes more sense to spend down other savings and investments such as bank accounts and Isa’s etc, before turning to pension funds in retirement. These changes to pension legislation may mean that we see pension savings being accessed sooner to avoid them forming part of the IHT calculation down the line.
As part of the changes pension scheme administrators will become liable for reporting and paying IHT due on pensions to HMRC.
The government estimates that, out of around 213,000 estates with inheritable pension wealth in 2027 to 2028, 10,500 estates – or around 1.5% of total UK deaths - will become liable to pay Inheritance Tax where this would not previously have been the case. Around 38,500 estates will pay more Inheritance Tax than would previously have been the case. This group are forecast to have an existing average Inheritance Tax liability of £169,000, increasing by around £34,000 on average when pension assets are included in the value of the estate. These figures do not take into account potential behavioural changes following the announcement of these measures, such as people drawing down pension funds at a faster rate and/or making greater use of other exemptions or reliefs to reduce their estate’s overall Inheritance Tax liability.
Most UK registered pensions schemes are currently beyond the reach of IHT as unused pension funds from discretionary schemes (most private pensions) do not form part of an individual’s estate, however some schemes such as NHS and Judicial schemes are treated as being part of an estate.
Any pension wealth liable to IHT will be taxed at a rate of 40%. Not only this, where a pension holder dies after age 75 their beneficiaries pay income tax on withdrawals, so this could be 20%, 40% or even 45% income tax.
Many people will need to revisit their retirement income planning strategies and we may even see people more willing to ‘give with a warm hand’ by gifting to family whilst they are still alive to avoid leaving pensions untouched and liable to IHT.
Alternative Investment Market changes
Investing in Alternative Investment Market shares, either directly by buying shares of companies listed on this exchange or through packaged investments products, may after today’s budget be less attractive to investors.
Previously, 100% of the value of AIM shares was exempt for Inheritance Tax (IHT) under Business Property Relief rules (BPR). Today it was announced that only 50% of the share or portfolio value will be exempt leaving the remainder to be taxed at a rate of 20%, which is a lower rate that the usual IHT rate of 40%.
Investments on the AIM market can be highly volatile due to lower liquidity and the speculative nature of many companies listed there, it’s often referred to as the ‘Wild-West’ of the London Stock Exchange.
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