Tax battle’s gift horse
MORE families than ever are being hammered by inheritance tax (IHT) but many have a brilliant way of fighting back without realising it.
Your pension is your secret weapon in the battle against HMRC, provided you use it carefully. It does takes diligent planning, though.
Many do not even realise this is an option, and lose out as a result. IHT is regularly voted the UK’S most hated tax and it is getting more punitive, with the £325,000 nil-rate band frozen since 2009, eroding its value in real terms. It will remain frozen until at least 2028.
The Treasury took a record £7.1 billion in IHT receipts in the 2022/23 tax year and this will continue to climb, said later life advisors Just Group’s director, Stephen Lowe: “Frozen thresholds and rising property values have dragged more estates into paying the tax.”
Probably the best-known way to reduce your exposure is through gifting. Every year, you can gift £3,000 to anybody you like, with instant IHT exemption.
If you forget to use the previous year’s allowance, you can mop that up too. Couples can double down with their gift allowances.you can also give unlimited gifts of up to £250 to any number of people, provided they haven’t benefited from the £3,000 exemption that year.
Parents can also gift £5,000 to children on marriage, £2,500 to a grandchild or great-grandchild who is marrying, and £1,000 to another relative or friend.
In a little-known exemption, gifts paid out of surplus income, such as from a job, pension or dividends, also fall out of your estate for IHT purposes, provided this does not affect your standard of living.
The rule could apply, say, to regular payment’s into a children’s savings account, or helping a young adult with rent. Other gifts will only be free of IHT if you live for seven years after making them, under the partially exempt transfers rule.
If you have exhausted these options, remember that you still have your pension, said advisory group Nucleus Financial’s technical services director,
Andrew Tully: “There are many benefits to saving into a pension. One key but often overlooked advantage is that when you die, any unused pension falls outside of your estate for IHT purposes.”
This does not apply to other forms of savings, including Isas.while they are free from income tax and capital gains tax in your lifetime, they may become liable to IHT if your total worth exceeds the thresholds. The moment you take money out of your pension, it instantly becomes part of your estate and may be subject to IHT.THIS includes the 25 per cent tax-free cash element.
Tully said consider using up other retirement savings, including Isas, before making pension withdrawals. “By leaving your pension until last, you could potentially pass more of your wealth to those you love.”
Not everybody will be able to do this, of course, because they need every penny of their pension. But for those who can, it could be a great way to cut IHT liability.
Unused pensions may not escape tax altogether, though.
If you die before age 75, they can be inherited entirely free of tax. However, if you die later than that, the money will be added to the beneficiaries’ total earnings for that year, and subject to income tax at their marginal rate.
There is a shadow hanging over the pensions IHT break, amid speculation that Labour could scrap it if it wins the next election. In that case, all that planning will have been in vain.
At that point, families may have to shift their strategy and use other methods of reducing their IHT exposure, assuming there are any means left by then.