A little-known loophole: the potential to use a pension for a large inheritance tax break

Mar 21, 2018

There is a little-known inheritance tax loophole that can save families a fortune. This came in to effect in 2015 as a result of the pension reforms by George Osborne, but is fairly unknown.

In very broad terms, the tax that applied to pension assets on death – otherwise known as the ‘pensions death tax’ – was abolished.  Instead, where the owner of the assets is over 75, the recipients of the cash only pay tax on the money when it’s drawn and at his or her rate of income tax, transforming the pension into a very efficient vehicle for mitigating inheritance tax. If that same person was to die under the age of 75, the recipients of their unspent pension cash aren’t taxed at all.

Tax expert Owen Kyffin, director of Whitley Simpson, which is one of the largest accountancy practices in the area, advises on the scope of this loophole.

Owen explains: “Your pension can be your biggest inheritance tax break. For some better-off people, the best use of a pension might well be to leave it untouched and pass it on to your heirs. The income you need to fund your retirement should then come from other, non-pension investments.”

Until 2015 pensions were never treated in quite the same way as the rest of a person’s estate for inheritance tax purposes. They fell outside the estate but attracted a high rate of tax on their owner’s death – whether or not there was any inheritance tax due on other assets.

George Osborne’s reforms in 2015 ended that system, and suddenly there was an incentive not to draw on a pension. The strategy can save many people a great deal of tax, as pension pots of around £1m (more in some cases) can be passed on tax free.

“If your property and other wealth mean your estate is likely to incur death duties, and if you have money in a “defined contribution” or “pension pot” style pension, then yes, this would help you. There probably is room to whittle down your inheritance tax liability by preserving your pension and spending other assets you may have instead.”

Owen concludes: “The alignment of the owner of the pension with the person who will inherit the money can be hugely helpful. It means generations can plan together to share wealth and savings with less worry about a great Inheritance Tax swipe. It is also a big incentive for older, especially wealthy, earners to top up their pensions.”

For further advice on these matters please contact tax expert, Owen Kyffin, on 01295 220914 or owenk@whitleystimpson.co.uk