Video looks at how pensions can be an excellent inheritance tax planning and may be now one of your main tools to reduce inheritance tax.
“Hello there. Pensions as an inheritance tax planning vehicle. There’s a strange one. So I just want to talk through initially, just very quickly, what the death benefits are under a personal pension.
[So] death benefits plain and simple:
if you die and you haven't touched your pension benefits then 100% of that pension fund can be paid out to your loved ones (and what I’ll do is probably deal with this under the new pension rules that start April 2015, so it's new rules after April 2015.
if you die and you haven't touched your pension fund, whether you are below age 75 or over the age 75, if you haven't touched your pension fund at all then, and what I mean by touched, I mean taken any money out of it, then that pension fund can be paid out inheritance tax free, benefit free, to your loved ones and they can then draw the money down from that pension tax free themselves.
if you die after age 75 but you have taken some form of benefit then there is potentially tax payable. So I’ll just make the distinction here
1. if you haven't touched your pension at all and you pass away that's paid out tax-free to your loved ones
2. the second one is if you have taken benefits from your pension for example: you may have taken the tax-free cash lump sum or you may have started to draw down benefits under the new rules, if you die before age 75 the whole of that pension fund can be paid out potentially tax-free to your loved ones. If you die and you've taken some money out, you’re in drawdown, after age 75 then that is potentially taxable.
3. Under the old rules would be the tax charge of 55% or up to 55%
4. Under the new rules basically it reduces to 45% and then moving onto 2016/17 it then gets taxed on your on your loved ones at their marginal rate of income tax.
So if they are non-taxpayers they can potentially drawdown money still tax tax-free, if they’re a basic rate taxpayer they pay 20% higher rate taxer, 40% et cetera.
So that’s all well and good and what I was doing, I was playing around with the numbers as ever, here’s my little iPad that I scribble ideas on and things like that and I just want to run through this one with you:
Let's say you’ve got £80. £80 and you put it in and ISA, so you put your £80 into an ISA and then you die. If you're over the inheritance tax threshold and you die, your £80 forms part of your estate and that would be taxed, from an inheritance tax perspective, at 40%. So on that that would be a tax bill of £32 in your loved ones get £48. So you’ve paid £80 into your ISA, you've passed away, inheritance tax of 40%, they receive a net benefit of £48.
What about now putting into a pension fund instead?
You pay in £80 into a pension and I’m just using £80 for round numbers, you pay in £80 into a pension, with tax relief [because] even pensioners and children can pay into a pension fund even if they're not working and pay up to £3600 a year, but you pay in £80, it’s instantly with tax relief made up £100.
£100 in your pension fund, as I’ve said earlier, if you die and you haven’t touched benefits, the whole thing can be paid out tax-free but what if you have passed away? What if you start to draw down benefits from your pension fund?
Well that £80 then if you die before age 75 no tax, if you die after age 75 then your loved ones get potentially taxed, like I’ve said initially 45% but then in 2016/17 drops down to their income tax rate.
So the reality there is: you paid in £80, it was made up to £100.
If you die and you haven't touched any benefits £100 pounds is paid out inheritance tax free.
If you die after age 75 [and you’ve taken some benefits] and we’ve passed over 2016/17 when the tax rates reduce, even for a basic rate taxpayer, if your loved one your children et cetera are basic rate taxpayers £100, if you remember it was £80 made up to a £100, they draw it all down, they get taxed at 20% or a £100 pounds even for a higher rate taxpayer they pay 40%.
So your £80 made up to a hundred even if you died later on, a basic rate taxpayer loved one they would receive £80 or a higher rate taxpayer loved one they would receive £60.
Now, that’s still better than putting it in an ISA, where they would only get £48 if you are subject to inheritance tax. So just a little bit of an idea for you, talk to me about using your pension fund for effective inheritance tax planning.
So pensions aren’t now just about retirement planning and here’s another one for you:
What if you paid into a pension fund, got your tax relief and then you pass away before age 75, let's say you'd left it to grandchildren and they were only 20 years old or your son or your daughter or whoever, and they've still got years and years to go before they get to age 75. They have potentially 50/60/70 years whatever, where they could draw that fund down and pay no taxes. Quite a lot going on with pensions.
Consider pension funds for inheritance tax and estate planning. Thanks very much for watching."
Read article on worked example of how pensions save inheritance tax.