Disappearing exemption

You may already know that it was the pension reforms made in 1986 that introduced personal pension plans (PPPs) as a replacement for retirement annuity policies. This revolutionised saving for retirement. A key feature of personal pension savings is that they are exempt from inheritance tax (IHT), that is until the exemption is abolished on 6 April 2027.

Tip. Remember that because of the way personal pension plans are set up they aren’t part of your general estate (even after April 2027). That means instead of specifying in your will who gets the remaining savings when you die, you must nominate the beneficiaries by notifying the pension company.

Family (tax) planning

The loss of the IHT exemption will, potentially, reduce the amount that the beneficiaries of your pension fund receive.

Example. Leo and Mia are married. Leo’s estate is worth £500,000 (including a 50% share of his home). In addition he has personal pension savings worth £400,000. Currently, Leo’s will gives his share of the family home and all his other assets to Mia, whereas he has nominated their children as beneficiaries of his pension savings.

If Leo dies before 6 April 2027 (assuming his worth remains the same), there’ll be no IHT payable because the value of his general estate is covered by the nil rate band (£325,000), the share of his home by the residence nil rate band (£175,000) and his pension savings are exempt.

If Leo dies after 5 April 2027, his estate for IHT purposes will include his pension savings meaning that the amount in excess of the nil rate bands (£400,000) will be taxed at 40% (£160,000).

If you’ve nominated someone other than your spouse/civil partner to be the beneficiary of your personal pension savings, consider changing your nomination in favour of your spouse/civil partner. This will dodge the IHT bill and give your spouse a chance to pass on your pension savings to the beneficiaries you originally nominated with less or no IHT by using standard planning methods such as lifetime gifts etc.

To illustrate how this can work let’s take the facts from our previous example and look at the outcome if Leo dies on or after 6 April 2027.

Example. Leo changes the person nominated to receive his pension savings from his children to his wife. Because transfers between one person and their spouse/civil partner are exempt, the whole of Leo’s estate including the pension savings escapes IHT.

He includes a letter of wishes with his will asking Mia to make gifts to their children so that when she dies, any of the gifts made seven or more years before her death will be free of IHT; that’s a saving of up to £160,000. Making gifts is just one of the IHT-saving strategies Mia could use.

And finally. Before changing the nominated beneficiaries of your pension savings, speak to your financial advisor (if you have one) to make sure it doesn’t disturb any other IHT or tax mitigation plans that have been put in place.