Pension Funds & Potential Inheritance Tax Traps

Maybe you’re able to access your private pension savings right now, but are still working, don’t particularly need the cash, and as result you don’t give it a thought. Yet, were you aware that leaving your money untouched could expose your estate to extra inheritance tax?

Access to pension savings

Current rules allow you to take benefits from your pension savings at 55, set to rise to 57 in April 2028. There’s no obligation to use any pension savings, you can leave them intact indefinitely and any increase in value is tax free unless value exceeds the so-called ‘lifetime limit’ of £1.1m. However accumulating funds can have tax consequences if there’s a stash of pension savings when you pass away.

Pensions and Inheritance Tax

Usually, pension policies are written in a way that means money and assets in them when you die don’t belong to your estate, they’re outside the scope of inheritance tax. Relatives pay income tax on receipt of them with no prior inheritance tax charge. 

Notwithstanding the above, inheritance can apply if in especially poor health in the 2 years before you die, when you pay significant amounts into your pension which has the effect of reducing your estate for inheritance tax purposes and increasing inheritance-free pension savings.  This can attract inheritance tax via HMRC.

Other Inheritance tax risks

Inheritance tax can apply where money is derived from pension funds in the following ways:

  1. Pension plan is pre-July 1986: referred to as retirement annuity contracts (RACs), these are not the same terms as later pension plans – the fund counts as part of your estate for inheritance tax purposes unless created as a trust with beneficiaries.
  2. A transfer of pension benefits: in the 2 years before death, you’re in very poor health and assign pension benefits to someone other than a spouse or civil partner.
  3. Control over pension savings changes: if the pension company is obliged by terms of the policy to pay pension savings to one/more persons nominated. Not to be confused with the form on who to benefit from your fund when you die – ‘expression of wishes’ is non-binding and not subject to inheritance tax anti-avoidance rules. 

Pension savings aren’t usually liable to inheritance tax even if you defer accessing them.

However, inheritance tax can apply if you’re in especially poor health and increase your pension contributions significantly, defer taking or assign your pension rights to others. In this situation, take expert pension advice before changing your pension arrangements.

See also Do you understand inheritance tax (blog).

Let’s Talk

For advice on your future financial position including how to handle pension pots ahead of time, get in touch with our team of experts on Let’s Talk.

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