Retirement income and inheritance tax - save on your IHT bill

September 23, 2022

Retirement income and inheritance tax - save on your IHT bill

Pensions are probably the first thing you consider when thinking about retirement income. Yet, if your estate could be liable for Inheritance Tax (IHT), it could make sense to use other assets first.

If your estate is subject to inheritance tax (IHT) when you die, it can significantly reduce how much you leave behind for loved ones. Considering the order in which you spend your assets in retirement can reduce your IHT bill.

Inheritance Tax receipts reached a record high in June 2022

According to HMRC, IHT receipts between April 2022 and June 2022 were £1.8 billion. That's £0.3 billion higher than the same period last year. IHT receipts reached a record high in June 2022 due to high-value payments. Due to inflation and a freeze on thresholds, HMRC expects IHT payments to continue to rise.

The value of some of your assets, such as property or an investment portfolio, may be rising. Yet, the thresholds for paying IHT are frozen until 2026. As a result, more families expect to pay IHT if they don’t take steps to reduce their tax liability.

There are two key allowances to consider if you’re reviewing if your estate could be liable for IHT:

1. Nil-rate band: For the 2022/23 tax year, the nil-rate band is £325,000. If the value of all your assets is below this threshold, IHT will not be due.

2. Residence nil-rate band: You can tax advantage of this if you leave certain properties (including your main home) to your children or grandchildren. For the 2022/23 tax year, it is up to £175,000.

If you maximise both allowances, you can pass on up to £500,000 before IHT is due.

IHT is not due when you’re leaving assets to your spouse or civil partner, and you can also pass on unused allowances. So, if you’re planning as a couple, you may be able to leave up to £1 million without paying IHT.

The standard IHT rate is 40%. If your estate is liable to IHT then it's important to take proper financial planning. This will enable you to pass on more to your loved ones whilst still enjoying the retirement you hoped for.

Two popular options are to 'gift' assets during your lifetime or make charitable donations. The other option that is often overlooked is to leave your pension untouched.

For Inheritance Tax purposes, your pension is outside of your estate

Your pension is likely to be one of the largest assets you have. According to a report from the Office for National Statistics, private pension wealth represents a greater share of household wealth than property.

Crucially, your pension is usually considered outside of your estate for IHT purposes. This means it could make better financial sense to use other assets first, leaving you your pension for your loved ones. The beneficiary of the pension may need to pay Income Tax at their nominal rate when they access the savings. The rate will depend on the age you die and how they access it, but it could be lower than the IHT rate.

It's important to understand how you’ll create an income in retirement - one that allows you to meet your goals, and reduce your IHT. This is where long-term financial planning is important. As part of this, cash flow planning can help forecast future income and is one of the services we provide for our clients.

You will need to complete an expression of wishes to pass on your pension

Your pension isn’t covered by your will. The pension scheme administrator has the final say over who receives your pension when you die. You can use an 'expression of wishes' to tell the administrator who you would like your beneficiaries to be. It’s important you complete this - if you don’t, your pension may not passed on to the person you want. You will need to complete an expression of wishes for each pension you hold.

Creating a long-term financial plan that suits you

When you plan your retirement or pass on wealth, it’s normal to have lots of questions. We’re here to help you answer them and provide advice. We can help you to mitigate IHT or help you understand how to use your assets to create financial security in retirement.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. The Financial Conduct Authority does not regulate will writing, tax planning, or estate planning. A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The value of your investments (and any income from them) can go down as well as up, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances. Levels, bases of, and reliefs from taxation may change in subsequent Finance Acts.

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