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Inheritance tax: How a pension could shield your estate from a hefty tax bill | Personal Finance | Finance


Inheritance tax takings by the taxman have hit the best they’ve ever been with HM Revenue and Customs (HMRC) taking £6.1billion within the 2021-22 tax 12 months. Inheritance tax is a tax paid on an estate of somebody who has died and includes an individual’s property, money and possessions. The brink, or nil rate band, at which families pay inheritance tax has been frozen at £325,000 since 2009 and is to stay frozen at this rate until 2026.

Anything above the £325,000 threshold, which applies to each individual, is then taxed at a rate of 40 percent – although some can increase their threshold.

While the estate owner doesn’t pay the tax themselves,  it will possibly take a sizeable chunk out of what an individual’s beneficiaries can receive.

There are various strategies, starting from using ISAs and trusts to writing a legally valid Will and making potentially exempt transfers, all of which can assist someone reduce the tax liability on their estate. 

One other certainly one of these tactics involves using a pension to cut back the worth of an estate, ensuring that somebody can leave more of their wealth to family members reasonably than HMRC.

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It’s because pensions normally fall outside of an individual’s estate for inheritance tax purposes.

Some conditions will apply depending on how old someone is after they die and the style of pension they’ve in place.

If someone has an outlined contribution pension, it’s relatively straightforward to pass their savings.

Alana Fairfax, financial planning author at Hargreaves Lansdown said: “Normally, pensions fall outside of the estate for tax purposes and you may name as many beneficiaries as you want and in most circumstances, there’s no inheritance tax for them to pay.


“For those who die before you’re 75, and your pensions are below the lifetime allowance, your beneficiaries can normally withdraw what they like out of your pension without paying any tax in any respect.”

The lifetime allowance for most individuals is currently £1.07million within the tax 12 months and has been frozen at this level until 2025-26. 

If this allowance is exceeded, a tax charge have to be paid on the quantity above the allowance. 

Nonetheless, any pension that a beneficiary inherits won’t count towards their very own lifetime allowance.

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Individuals are warned that an individual’s beneficiaries have two years to say the pension pot with this plan. 

If an individual is over the age of 75 years, the defined contribution pension won’t be subject to inheritance tax. Income tax will must be paid on it at the standard rate.

If someone dies before they’re 75 years but has already began accessing their pension through drawdown, it’s possible for the beneficiaries to access the pension pot as a tax-free lump sum. 

On this instance, the beneficiaries may select to make use of the cash to purchase an annuity and won’t should pay tax on any of the payments they receive.

If an individual has an outlined profit pension, which can be often called a final salary pension, they could find it tougher to pass it on. 

If someone hasn’t retired but dies before 75 years, the beneficiary will normally receive a tax-free lump sum.

Nonetheless, if someone is older than 75 after they die it’s likely that their spouse, civil partner or dependant will receive a portion of the pension. This also could also be subject to tax charges.

Experts recommend people take skilled advice on how they’ll plan their inheritance because the plan could be tailored to someone’s personal circumstances which could help more wealth be passed on. 

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