Quick fixes to lower your inheritance tax liability

Farmers are up in arms over inheritance tax changes; for the rest of us, I suspect complaining about IHT on our pension after the Budget is the new form of “humble bragging”. In the words of one adviser: “Inheritance tax has become a class problem to have.”

Where the problem is most acute is if you, or your parents, are over 80 — and expect to live beyond April 2027, when the government plans to bring pensions back into the inheritance tax (IHT) net. You might be on the hunt for any quick fixes you can find.

For the past decade, there has been no IHT to pay on pension assets left to family. So if you had other sources of income such as an Isa or property, you shrewdly kept your pension to spend until last.

Under the new rules, if the value of your estate surpasses the nil-rate bands (which, if you’re married and own a home add up to £1mn) your beneficiaries stand to inherit less than half of your pension. That’s because it will first have IHT levied at 40 per cent; then your children will pay income tax on the proceeds. If they’re in their 50s or 60s, they could be at the height of their earning powers. Depending on whether they’re basic, higher or additional rate payers, they will pay a combined 52, 64 or 67 per cent IHT and income tax on inheriting that pension.

It could well be that many older couples in long-term relationships decide to tie the knot

If the addition of your pension savings pushes the total value of your estate over £2mn, the nil-rate band for property left to direct descendants starts to disappear — by £1 for every £2 over the threshold. Once it’s gone, advisers say your beneficiaries could be looking at a combined tax liability of over 80 per cent. Another issue to humble brag about?

First, there may be no rush to act. On average, at 80, you have 10 more years to live. While, if you have a younger, healthy spouse, the IHT bill will be even further away — wealth (including pension) left to a spouse or civil partner is exempt. So the IHT “problem” only really arises when you are the surviving spouse.

“It could well be that many older couples in long-term relationships decide to tie the knot,” says Gary Smith, financial planning partner at wealth manager Evelyn Partners.

It’s a quick fix of a sort, I guess.

If you’re not in the mood for romance, you might consider charity? Leaving 10 per cent of your net estate to charity can lower the rate of IHT paid on the remainder of your estate to 36 per cent.

Otherwise, the most popular action suggested is “stripping” your pension to pass on during your lifetime. If you haven’t taken your 25 per cent tax free cash lump sum, do that first. After that you can draw an income — as annuities aren’t generally sold after age 75, you’ll need to draw down directly from the pension pot.

Yes, you’ll pay income tax on the amount drawn, but your beneficiaries would have to do that too later (possibly at a higher rate). Plus, if you can pay a lower income tax rate when drawing it out than the relief you received when contributing, you’ve still “won” against the Revenue. “If you have £500,000 left in your pension in your 80s, the chances are you received quite high tax relief on pension contributions,” says James Baxter, founder of wealth management firm Tideway Wealth.

Even if you now have total income of £150,000, overall you’re paying 34 per cent income tax. That still leaves you “up” if you received 40 per cent relief on the pension contributions.

But what to do with the cash drawn from your pension? Gifting is the simplest and best solution — and it’s enjoyable. Research from RBC Brewin Dolphin found 70 per cent of Britons who had given at least £1,000 to family members found gifting positively impacted them.

The rules on gifting lump sums involve a complex web of allowances and the seven-year rule — live for longer than that and anything you give is IHT free. But the most powerful gifting opportunity relevant to pensions relates to gifts out of surplus income.

To help your beneficiaries satisfy HM Revenue & Customs, keep records of your regular income and show you’re not having to cut back on your normal spending

There’s no limit to how much you can give away immediately free of IHT, as long as you can afford the payments after meeting your usual living costs and you pay from your regular monthly income.

To help your beneficiaries satisfy HM Revenue & Customs, keep records of your regular income and show you’re not having to cut back on your normal spending to make them.

For tax efficiency, encourage beneficiaries to contribute the money to their own pensions or Isas.

The worry with gifting is how to pay for any potential care costs you might need down the line.

One efficient way of keeping the money drawn from your pension yourself is to invest it in Aim shares — but highly volatile investments are not a good bet for someone in their 80s. Plus, after the Budget, IHT is now chargeable on Aim shares at a rate of 20 per cent.

A more appropriate route is to invest in unquoted investments qualifying for business relief. Portfolios run by firms such as Octopus and Foresight target less volatile, lower growth investments in renewable energy, superfast fibre broadband infrastructure and real estate. Providing you live longer than April 6 2026, there’s 100 per cent IHT relief on up to £1mn of qualifying investments, provided that they have been held for at least two years.

If these quick fixes sound like too much trouble, how about doing nothing at all?

Keeping your money in the pension means it can continue to grow free of tax and benefit from the powerful effect of compounding. If you get a 7 per cent annual return on the money, Tideway Wealth calculates the IHT paid on your death will be recouped within 20 years.

So Baxter says: “Try to leave your pension accounts to someone who can keep them invested for 20 years without drawing on them. Grandchildren are the obvious beneficiaries.”

Moira O’Neill is a freelance money and investment writer. Email: moira.o’[email protected], X: @MoiraONeill, Instagram @MoiraOnMoney