The ultimate inheritance tax dodge

Death duties are on course to catch out 250,000 families by 2028. Charlotte Gifford explains how to beat the Chancellor using your pension

Families have just been handed a huge inheritance tax break as revenue for Britain’s most hated levy is projected to hit an all-time high. On the day of Jeremy Hunt’s Budget, the Office for Budget Responsibility (OBR) revised its forecast for how much IHT will cost families over the next five years.

It now estimates the freeze on IHT thresholds will rake in £45bn by 2028 – £3bn more than the Treasury previously expected.

IHT receipts were already on track to break records for this year but now they are expected to be even higher, reaching £7bn in 2022-23 alone.

Between now and 2028, 250,000 estates will pay in an IHT charge, the figures reveal.

The proportion of deaths incurring up to 40pc tax will rise from 4pc in 2020 to 6.7pc in 2028, the OBR’s new forecasts reveal. Stephen Lowe of retirement company Just Group said that means one-in-15 deaths will be hit by the death charge in a “major boost for government coffers”.

House price inflation is a key driver of ballooning IHT receipts. The average property in London is now worth £526,842, according to the Halifax house price index. But the main IHT allowance and family home allowance are frozen at £325,000 and £175,000 respectively, giving an individual £500,000 in IHT-free allowances – still not enough to cover the average value of a London property.

However, families were handed the most significant IHT giveaway in years when Mr Hunt announced last week that the pensions lifetime allowance of £1.073m will be scrapped.

While inherited pensions can be subject to income tax, families often forget that pensions are IHT-free. The abolition of the LTA means families can technically stash away “unlimited” sums free of IHT, capped only by the annual allowance, which Mr Hunt increased from £40,000 to £60,000.

Dean Butler of pension company Standard Life said the removal of the lifetime allowance had “supercharged” the attractiveness of pensions as a means of passing on wealth from generation to generation.

Tom Selby of investment platform AJ Bell said using pensions to avoid IHT will become a “no brainer” for savers. He added: “Money left in pensions can be passed on to your nominated beneficiaries IHT-free, and completely tax-free if you die before age 75.”

There are a number of reasons why saving into your pension is more appealing than other strategies for avoiding IHT, such as investing in assets that qualify for “business relief” or setting up a trust.

Andy Butcher of wealth manager Raymond James said: “Trust arrangements can be complex and difficult to navigate, whereas leaving a pension to your beneficiaries is a simple process if done correctly. There is also the added benefit of tax relief when adding to the pension versus a potential tax charge of 20pc when setting up a trust arrangement.”

Any money held in qualifying shares listed on the Alternative Investment Market are also free of IHT. But investing in these companies can be risky. Jason Hollands of the platform Bestinvest said the regulatory requirements for companies listing on the Aim are much lighter-touch than they are for the main London stock market, so choosing solid investments can be a minefield for investors.

“There have certainly been a number of significant successes on the Aim, such as Fevertree Drinks and video gaming group Keyword Studios, but there have also been a number of blowups over the years such as ScotOil Petroleum, Patisserie Valerie and drinks wholesaler Conviviality. You really need to know what you are doing when investing directly in Aim shares,

‘Trust arrangements can be complex and difficult to navigate, whereas leaving a pension is simple’

you have to be super selective,” Mr Hollands said.

The amount you can save into a pension tax-free each year, and thus shield from IHT, has been increased by Mr Hunt from £40,000 to £60,000. You can carry forward any unused allowances from the previous three years. Ian Dyall of wealth manager Evelyn Partners said: “With carry forward, you could save £180,000 into your pension and then a maximum of £60,000 for each subsequent year.

“So technically it’s not unlimited but you could build up a very large pot, IHT-free.”

Calculations from the financial advice firm NFU Mutual show that if a saver put £60,000 into their pension every year for the next decade, then assuming 4pc annual investment growth, they could build up a pot of £812,298. This would give an IHT saving of up to £324,919.

Couples can share their allowances – so those who are married or in a civil partnership could leave behind a total of £1.62m free from IHT, giving them a potential tax saving of £649,838.

However, income tax will be due at the inheritor’s marginal rate if the owner of the pension dies after the age of 75.

“In some cases it might be more taxefficient for the pensioner to start drawing down,” said Mr Dyall, “for example, if they’re a basic rate taxpayer but their child is a higher rate taxpayer.

“However, if the parent is on the 40pc or 45pc tax rate while their child is on 20pc, passing on the pension could result in a huge IHT and income tax saving.”