Inheritance tax warning as countdown begins to major rule change – ‘make most of this’ | Personal Finance | Finance

Pensioners looking to maximise the amount they leave loved ones after they die have been issued some important guidance. Helen Morrissey, head of retirement analysis at Hargreaves Lansdown says as of Monday this week, “the clock is ticking down” towards unused defined contribution pensions, like workplace pensions, becoming part of estates for Inheritance Tax (IHT) purposes.

From April 6, 2027 most unused pension funds and death benefits will be added to the value of the estate. Pensions generally sit outside of estates currently, and therefore aren’t included in inheritance tax calculations after you pass away. After April 6, they will be added to a pot taxed at 40% over the £325,000 tax-free threshold, known as the nil rate band. There is another band called the ‘residence nil rate band’ worth up to £175,000 that allows a single parent also bequeathing their family home to a child or granchild pass on up to £500,000-worth of their estate outside of inheritance, she explained. These benefits diminish if you’re handing over a very large estate, mind you.

People who are married or in a civil partnership have further options, such as such as the right to pass assets of any value to partners inheritance tax-free.

These beneficaries can also inherit any unused nil rate bands the deceased has, meaning a suriving spouse/civil partner can potentially pass on as much as £1million on death before their estate becomes subject to inheritance tax.

But some taxpayers will have to take into account how pensions could enlarge their taxable estate and pull them into levies they currently aren’t subject to.

Ms Morrissey says the pension rule change coming into effect next year “has attracted a lot of attention, but it’s important not to panic – the number of estates liable for inheritance tax has grown, and will continue to grow, but they will remain in the minority so do check if it will be an issue for your family”.

“If there is a potential looming liability, there are steps you can take to lessen its impact, though it will need careful planning.”

One option to reduce your taxable assets is to gift away assets while you’re alive, and doing so seven years before has clear benefits. “There are various allowances you can make use of to reduce the value of your estate,” Ms Morrissey explained. “You can gift any amount of money to a loved one and it will fall out of your estate for inheritance tax purposes after seven years.

“These are known as Potentially Exempt Transfers (PET). If you die within that time, inheritance tax may need to be paid, though potentially at a reduced rate.”

There are also allowances you can use to transfer money out of your estate straight away, like using your £3k annual allowance to gift to loved ones.

Tax laws also permit a gift of up to £250 to any number of recipients, though this can’t be given to someone receiving a separate gift via another allowance.

The expert says doing so “would mean part of the gift would be classed as a PET, and you’d have to live for seven years after giving it for it to become IHT-free,”.

Allowances are also in place for those wishing to gift funds to a loved one who is getting married (up to £5,000 to a child, £2,500 to a grandchild or great grandchild, and £1,000 to anybody else, regardless of their relationship to you).

However, gifts of this kind have to be made either on or before the wedding, and the nuptials need to actually take place, Ms Morrissey says.

You can also leave make gifts to charities and political parties can also be made inheritance tax-free. On death, if you gift at least 10% of your net estate to a UK registered charity, you will also see the rate of IHT you pay on your remaining estate will drop.

Another important rule she flags is what tax experts call “gifting out of surplus income”.

This process allows you to give away any amount, with the funds coming out of you estate for IHT purposes straight away.

“However, there are rules,” she cautioned. “The gift needs to come from income, not capital. It needs to be made on a regular basis, and it must not affect your standard of living. Examples of this could include paying school fees for a grandchild or contributing to a Junior ISA.”

And while gifting is an effective strategy, Ms Morrissey says it’s important to keep careful notes of what has been given to whom and when, so your loved ones have evidence they can present if needed.

She also recommends doing it with the assistance of a financial adviser so no rules are inadvertently broken.

Additionally, you need to be aware of how the status of gifts can change depending on how they’re used. “So, for instance, if you were to gift your home away to a loved one but continue to live in it rent- free then it could be seen as a gift with reservation – i.e. you are still benefiting from it. If this is the case, then your estate could be landed with a bill.”

Trusts may also form part of your inheritance tax strategy, but due to their complexity you could still face an ineritance tax bill, so getting a professional to eplain your options is key.

She issued a word of caution for cohabiting couples, as unlike married couples they can’t benefit from inheriting assets of any amount, or their partner’s nil rate bands.

“This can come as a nasty shock at an already difficult time so it’s worth planning in advance as well as making sure important documentation, such as wills and expression of wish forms for pensions, are updated and maintained,” she said.

And while dependents will likely be the main consideration for people as they make plans for after they pass away, Ms Morrissey emphasised the importance of not giving too much away too soon. Doing so can leave you short later in life and you may need savings to pay for your care, which doesn’t come cheap.