Changes to inheritance tax rules could mean some families will see 91% of inherited pensions being swallowed up by tax due to a triple tax hit, NFU Mutual has warned.
Unspent pensions currently sit outside the IHT net so if an individual dies under the age of 75 their beneficiaries do not pay income tax when taking money out. However, this will change from next April when unspent pension pots are included within IHT calculations.
The existing £325,000 IHT allowance is available to everyone and those leaving a property to direct descendants can also benefit from the Residence nil rate band (RNRB), which lets them pass on an additional £175,000 tax-free. Married couples can also share their allowances allowing a couple to pass on £1m to their families without paying IHT. Inheritance tax is then charged at 40% on estates after IHT allowances have been used up.
However, the Residence nil-rate band is reduced for estates worth more than £2m at a rate of £1 for every £2 the estate exceeds £2m. If the Residence nil-rate band is entirely wiped out then a married couple can only use their combined £650,000 IHT allowance to offset any IHT bills. If a pension holder dies after the age of 75 then beneficiaries will also pay income tax on any pension withdrawals at their marginal rates.
Sean McCann, chartered financial planner at NFU Mutual, said: “The changes from April will mean some families will be hit with a triple tax blow, through a combination of inheritance tax on the pension, loss of the tax break on the family home and additional income tax if their loved one dies after age 75.
‘’There are steps you can take to mitigate the impact, including ensuring you take your tax-free lump sum before age 75, while it may still be subject to inheritance tax it will avoid an additional income tax charge’.
“We expect to see more people taking regular income from their pensions, making use of the unlimited ‘gifts from normal expenditure’ exemption. This allows you to give regular gifts out of income, which provided they don’t impact your normal standard of living are immediately exempt from inheritance tax regardless of whether you survive seven years.’’
He added: “Before deciding to make big changes, it’s important to take advice to ensure that in a rush to avoid the worst of April’s tax changes you don’t compromise your future financial security.’’
