My wife and I are both 41, have two young children aged 6 and 4 and never considered inheritance tax to be a problem until the budget raid on pensions.
Our house is worth around £1.2 million with an outstanding mortgage of £300,000 and between us we have around £100,000 in savings and investments.
My defined contribution work pension is currently worth about £300,000 and my wife has an old work pension worth about £10,000 and a Sipp worth about £40,000.
In our will we leave everything to each other if one of us dies and in the terrible scenario where we both die, we leave everything to the children.
As it stood before the Budget, they could have the house, our savings and our pensions without losing any money to inheritance tax.
Would our children now lose 40 percent of our pensions due to inheritance tax?
My rough pension projection is that if I continue to spend £1,000 a month on my work pension and get a 6 per cent annual return, the pot would be worth £710,000 in ten years.
If something terrible were to happen to me and my wife, would my children aged 16 and 14 now lose £284,000 of that to inheritance tax? How can this be fair?
Caught: Those building up a pension pot for their retirement who are unlucky and die early may now find their estate has an inheritance tax bill
Ian Dyall, wealth planning specialist at Evelyn Partners, replies: The 2024 Autumn Budget announced the government’s intention to impose inheritance tax on most pensions paid to beneficiaries on death.
If you die with unused funds in your defined contribution pension (unlike so-called final salary schemes), this can be transferred to a designated beneficiary without inheritance tax.
If you die before age 75, beneficiaries can also withdraw the money free of income tax, but if you die after age 75, they will pay tax at normal income tax rates on any money they withdraw.
This will change from April 2027. Any unused defined contribution pension funds and any lump sums on death from defined benefit pensions will be subject to inheritance tax.
Again, if the beneficiary withdraws the money, they may be subject to income tax, depending on whether you die before age 75 or not.
Not all death benefits are intercepted; it only concerns benefits related to pensions. People should therefore check with their employer whether their schemes are covered by the new legislation.
Ian Dyall: Pensions now fall into the IHT net
The method of payment of the liability is currently complicated, but subject to consultation.
The value of the unused pension or death benefit is added to the remainder of your estate when calculating inheritance tax.
However, that liability will be split proportionately, with the pension provider paying part of the pension directly to HMRC and the remainder paid by the executors of the estate.
This will involve much more intensive communication between the pension provider and the personal representatives of the deceased’s estate and is likely to both increase the costs of administering the pension and lead to delays before the pension can be paid.
Applying this to your circumstances, you are correct in thinking that under current law you would not have to pay inheritance tax if you and your wife were both to die today.
You have a nil rate of £325,000 each and an additional nil rate of £175,000 for your residence, which you can use to pass your home to direct descendants, provided your total estate is worth less than £2 million at death.
If you do not use the allowances on the first death, perhaps because you leave everything to your wife, then the allowances will be transferred to your wife so that she can use both her allowances and your allowances on her death, a total of £1 million (of which assuming she isn’t). worth over £2 million at her death).
It’s worth pointing out that the allowances are now locked in until 2030, and even before the changes take your pensions into account, you’ll be on the borderline of owing inheritance tax, with a net worth worth £1 million and total grants worth £1 million. Any growth in your non-pension assets will therefore likely result in inheritance tax.
If the new rules are introduced in their current form, your pensions will be subject to inheritance tax at 40 per cent on your death, assuming they are higher than your nil rate allowances when added to your other assets.
For some people it can be even worse. If their pensions take their total assets above £2m, the pension funds could also see their zero interest rates fall. This is not entirely clear from the budget briefing documents, but it appears to be the case.
Whether the proposed changes are fair or not is up for debate, but it is worth pointing out that being able to pass on your pensions tax-free is a relatively new phenomenon, introduced at the same time as the pension freedoms in April 2015.
Previously, if you died over 75, there was a 55 percent tax on any unused pension funds if left to a non-dependent beneficiary. This was a tax on all unused pension funds, regardless of the pension holder’s other assets.
Currently, only about 6 percent of people are subject to inheritance taxes. Taxing unused pension funds through inheritance tax will mean that many people will not have to pay tax on their pension when they die, although this may still increase the complexity of managing their estate.
What can people do about this?
Firstly, if their pension is through their company, they should ask the company to clarify which parts of any death benefits may be subject to inheritance tax under the new rules. This may result in the company structuring the death service in a different way.
As you build your retirement, the rest of your planning should take into account potential inheritance taxes.
Pensions are still very tax efficient vehicles for income tax and capital gains, so the new legislation should not deter people from contributing to pensions.
Once your pensions have been paid out, you will need to consider whether you need the full pension fund you have and whether you are likely to have surplus funds at your death.
There are a number of options to consider if you don’t need all the money you’ve collected.
Possible options include taking your tax-free money and donating it. If you live for seven years, the money is excluded from your estate for inheritance tax purposes.
You can take more income from the pension than you need and give it away or use it to fund a managed whole life insurance policy.
The extra money you take with you probably falls under the ‘normal expenses from income’ exemption and is therefore immediately exempt from inheritance tax.
There are other options and seeking advice in times of change like this is worth it if you think you are likely to be liable.
The simplest option is of course to simply spend your pension. What would you spend your money on if everything was on sale for 40 percent off?
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