Triple whammy inheritance tax raid on pensions...up to 87% tax??....Now what?

The recent Budget has thrown a spanner into Pension planning...and a rather large one at that!

For many individuals, pensions have long been a cornerstone of their retirement planning, offering financial security and a potential legacy for loved ones free of inheritance tax. However, the new rules could significantly (and I mean really significantly) impact the value passed down to future generations.

First, here's a quick reminder of the Pension rules, before the recent October Budget for Defined Contribution schemes (that's personal pensions, SIPPs and Small Self Administered Schemes/SSAS's).

• Funds remaining in a pension could usually be passed to beneficiaries free of IHT.
• If the pension holder died before age 75, beneficiaries could inherit the pension tax-free.
• After age 75, beneficiaries would pay income tax on withdrawals from the inherited pension, but not IHT.

But the new rules announced in the recent October Budget propose that from April 2027, Pension funds be included within an estate for inheritance tax! That's a major shift in tax policy and one that could mean a much much higher tax hit than inheritance tax at 40%.

Let's consider the last bullet point above. In such circumstances, one would be hit with a 40% inheritance tax charge first, followed by an income tax hit when drawing on the Pension fund. For an additional rate tax-payer, that would be income tax at 45%, meaning a total tax raid of...

￡1m Pension fund taxed @ 40%. That leaves ￡600,000 for one's beneficiaries.

For a beneficiary who is an additional rate tax-payer drawing upon the fund, that would be income tax @ 45%, leaving just ￡330,000 remaining of the ￡1m - an effective tax of 67% ??!

As if that isn't bad enough...

In recent years, a residence nil rate band has been introduced. This provides an additional nil rate band ringfencing ￡175,000 of the value of one's home from inheritance tax. However, where one's estate exceeds ￡2m, this additional allowance decreases by ￡1 for every ￡2 of the estate above ￡2m. So, in the case of an estate worth ￡2.35m, the ￡175,000 residence nil rate band is completely lost.

Well, with Pensions now within the IHT net, a great many could unwittingly find themselves losing their residence nil rate band.

Consider an estate worth ￡2m, with ￡350,000 of Pension funds on top of that. Not only could one pay 67% tax as in the example above, but with the ￡175,000 allowance now lost, that's an additional ￡70,000 inheritance tax bill. In the case of a ￡350,000 Pension fund, that means a total tax bill of...

67% tax on ￡350,000 Pension fund = ￡234,500. That leaves just ￡115,500 for one's beneficiaries. Deducting a further ￡70,000 on the loss of the nil rate band leaves a measly ￡45,500 from a pot of ￡350,000!

An effective tax rate of 87%!

So, what can be done to avoid this particularly nasty tax trap?

Unlike other assets, Pension funds can't be 'gifted away' to avoid inheritance tax. Now, one could draw on their Pension fund beyond tax-free cash during their lifetime and aim to gift the funds away, but with withdrawals subject to income tax, that somewhat defeats the point.

Luckily help is at hand.

Our Financial Advisory practice established in 1998, is at the forefront of tax planning innovation and strives to reduce clients' tax liabilities as much as possible, by leveraging the generous tax reliefs available through various regulated investment vehicles.

This emphasis enables clients to reduce their exposure to the new pension tax liabilities by leveraging well-structured, non-contentious tax-efficient investment solutions.

However, there are no instant solutions. Particularly, for clients with larger pension funds, fully implementing these tax-planning strategies may require more time. The key is to begin the planning process as early as possible to maximise the benefits.

Get in touch and let's get the ball rolling...before it's too late.

Our financial advisory practice, established over 25 years ago, is well-placed to assist clients with a variety of different financial planning strategies, which combine to help them achieve their financial objectives as their circumstances evolve, as well as bring tax-saving opportunities to clients as they present themselves. Get in touch and see how we can help you.

Consultancy services for accountancy and law firms also available.

Arnold Aaron

Specialist Inheritance Tax Planning & Investments

78 York Street,

London W1H 1DP

T: 0207 692 0884

arnoldaaron.co.uk

e: [email protected]

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