Budget changes – Pensions – What does it mean for me?

Bringing pensions within the scope of Inheritance Tax has had further impact than it seems, because not only is Inheritance Tax now payable on the pension, the inclusion of this in your gross estate at death could push this over the £2 million threshold, at which point the residence nil rate band is tapered.

If your gross estate exceeds £2.35 million with the pension inclusion, the residence nil rate band is tapered to nil, resulting in a £140,000 increased Inheritance Tax cost for a couple.

It should also be noted, that pensions inherited after the age of 75 are subject to Income Tax on the individual receiving them. Worst case these are taxed at the 45% Income Tax rate.

If we consider the very worst case of a pension of £350,000, that takes the estate to a value of £2.35m, the effective rate of Inheritance Tax as a result of the pension inclusion is 60% on that £350,000. If we also factor in Income Tax, on the assumption the net pension is taxed on the beneficiary at 45%, this is an overall effective rate of tax of just over 87%.

Of course we should also be clear that the pension changes will not have this same impact for everyone. If the addition of the pension still leave you with a combined (per couple) gross estate of less than £1 million, then assuming there are no lifetime gifts to consider and full residence nil rate band qualification, there is no Inheritance Tax payable on the pension.

If your pension ceases on your death, or passes to your spouse and ceases on their death, then again, the pension changes have no impact for you and do not increase the Inheritance Tax liability on your estate.

What can you do if you are impacted? Take your tax free drawdown to at least reduce the Income Tax exposure on that element of the pension. If you don’t need these funds personally you may be able to gift them away outside the 7 year rule using the annual exemption (£3,000 per annum plus £3,000 from the previous year, if unused) and/or under the regular gifts out of income exemption.

If you would like to discuss your Inheritance Tax position in more detail, please contact 023 8046 1259 or email Gemma Hedges.