Helen Morrissey, head of retirement analysis, Hargreaves Lansdown: “The government’s plans to make unused defined contribution pensions subject to inheritance tax has thrown many people’s plans into disarray. Four in ten people are concerned about the impact of these changes. The more people earn, the more concerned people are – 69% of additional rate taxpayers said they were worried while just over half of those paying higher rate said the same.
The current position is that pensions are not usually subject to inheritance tax – if death occurs before the age of 75 there’s no income tax to pay either. This treatment has led to many people opting to spend down other assets first and leave their pensions untouched as long as possible, so they can be passed on to loved ones in a very tax efficient manner. The government’s moves have upturned people’s plans.
Instead of leaving pensions untouched until after death, it is likely that people will look to soften the effect of the tax by giving money away while they are alive. Gifts of any size leave your estate for inheritance tax purposes after seven years, so some will want to get that clock ticking down sooner rather than later. There is also an array of allowances that enable you to gift assets away and they move out of your estate immediately. Examples of these include the annual allowance of £3,000.
Gifting out of surplus income will also prove popular. This allows you to give away any amount of money and it won’t be subject to inheritance tax - as long as it can be proved that it comes out of your income, rather than capital. It will also need to be proven that gifts are given on a regular basis. Paying school fees is a good example. Make careful notes if you are going to go down this route in case HMRC asks questions of your loved ones, otherwise they may be clobbered with a huge bill.
However, it’s also important that you don’t fall foul of misconceptions around inheritance tax and take decisions you later come to regret. For instance, inheritance tax is only paid on estates worth more than £325,000 – this is known as a nil rate band. Added to this if you are passing on the family home to children or grandchildren you have a further £175,000 at your disposal. Assets of any value can be passed between spouses free of inheritance tax and the survivor can also inherit any unused nil rate bands. This means that a surviving spouse or civil partner can potentially pass on up to £1m free of inheritance tax. This is why only a relatively small percentage of people actually have an inheritance tax bill, so bear this in mind before making plans as you may be worrying unnecessarily.
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