Two pieces of information to completely change your retirement and inheritance tax planning strategy

When it comes to retirement and inheritance tax planning, many people worry more about what their money will do during their lifetime rather than once they have gone...writes Michael Hawthorne, Chartered Financial Planner at True Bearing.

When making the decision about their retirement income, considering the tax on their estate at death is rarely high on anyone’s list. It IS important to structure your money around the life you want to live first. However, if there is a potential Inheritance Tax bill to pay in the event of your death, especially if you have total assets over the nil-rate band, you should pay extra attention to the facts around my client’s story.
                                            
My client, let’s call her Brenda, has enough income from her work pension and state pension to pay for her desired lifestyle. Brenda has £15,000 in an old AVC (industry jargon for one of the many occupational type pensions) from a previous employer. Brenda is single and has total assets (property, savings and possessions) above £325k which is the Inheritance Tax threshold. 

‘The pension isn’t doing much’

Brenda’s plan was to ‘cash-in the pension to reinvest’ because ‘the pension wasn’t doing much’ and she ‘didn’t need the income’.

Let’s play out that scenario:

£15,000 paid out from the AVC to bank account
£12,750 received in bank account after 20% tax on 75%
£5,100 additional immediate increase in inheritance tax liability on death
£7,650 is the total amount left to the estate after inheritance tax is paid

Brenda has an extensive knowledge of tax from employment but was not aware of 2 key pieces of information which completely changed her financial plan for retirement.

1. Did you know that in most instances a Defined Contribution pension (more industry jargon for most types of personal and some work place pensions) is not subject to Inheritance Tax? And, as a result of Pensions Freedoms introduced in 2015, all money in this type of pension can be accessed from the age of 55?

How does that change anything? The £15,000 in the AVC could be left in a pension/AVC. Inaction actually saves Brenda’s estate £7,350 because if Brenda dies before age 75, the full £15,000 is left to her estate. Brenda’s investment strategy needs a little tweaking to reflect that it is now likely to be invested for 25+ years.

2. Though Brenda is retired, she is still able to contribute to a pension too. Brenda can make a payment of £2,880 per annum to a pension and receive income tax relief of £720 until the age of 75. Every £2880 contributed will also be outside of her estate for the purpose of Inheritance Tax which is an Inheritance Tax saving of £1152 per annum. This is all before any investment returns are considered. 

So, with an additional 2, seemingly small pieces of information, Brenda has completely changed her retirement strategy which still continues to allow her to live the life she wants but will likely reduce the Inheritance Tax bill for her estate by tens of thousands of pounds over the course of her lifetime whilst still providing access to the funds if they are required.

Who said you can’t have your cake and eat it?

Whilst I have explained the key points of Brenda’s case, it should be stressed that the world of pensions is complex and this solution for Brenda will not be right for others. This is an area I recommend you take professional advice but I also warn – there are significant benefits for doing so! 

*The FCA does not regulate Tax or Estate Planning. This blog is based on our understanding of current tax legislation.