‘My children could pay up to 90pc on their inheritance. What can we do?'
Write to Pensions Doctor with your pension problem: pensionsdoctor@telegraph.co.uk. Columns are published weekly.
Dear Charlene,
I'm worried that with the upcoming changes to pensions, my children are going to potentially face 'double taxes' on what I leave to them. I've read about tax rates of 50pc, 60pc and even 90pc in some cases.
I'm 75 next month (my wife is already 75) and my two children are nominated to get one third each of my fund, with my share of the house and Isas to pass to my wife (and vice versa).
I've already taken the tax-free cash from my pensions which now stand at £800,000. Our Isas and cash savings are worth £400,000 between us and the house could potentially be worth £1m.
I'm weighing up taking more money out of my pensions even though we can comfortably live off our current income. Will this do anything to help or am I wrong about the high tax rates?
Kind regards,
– Roger
Dear Roger,
The proposals to bring pensions into inheritance tax (IHT) have led to this policy being described as a 'double whammy'.
The current income tax rules on inherited pensions revolve around the age of the pension holder. This is not due to change under the proposals.
Currently, if a pension holder dies before age 75, with a defined contribution scheme like a Sipp, no income tax will normally be paid by their beneficiaries on money they take from the pension.
If the pension holder was over 75 when they died, their beneficiaries pay income tax on any withdrawals.
This is why many people have described the new plans as being 'double tax', because some beneficiaries could see the pot reduced due to inheritance tax, and then income tax when they withdraw cash if the pension holder died age 75 or over.
A spousal exemption for IHT will still apply to any unused pension funds left to spouses or civil partners but anything left could form part of their estate on second death.
The combination of IHT, then income tax, means that anything that passes to your children could face a tax charge of up to 52pc if they are basic-rate taxpayers when they withdraw any inherited funds, 64pc if they are subject to higher tax rate and 67pc if they pay the additional rate of income tax.
Estates worth more than £2m
The 90pc rate is an extreme example – but relates to how 'nil-rate bands' for IHT are reduced in certain circumstances. Every estate gets a nil-rate band of £325,000 on which no IHT is payable.
If passing property to a direct descendant, then an additional 'residence nil-rate band' of up to £175,000 each is also available. Both of these allowances can be transferred between spouses, so it's common to hear that a married couple can leave up to £1m tax free between them before IHT applies.
Where an estate exceeds £2m the residence nil-rate band starts to be reduced at a rate of £1 for every £2 over the threshold, until it disappears for estates over £2,350,000.
The cumulative effect of the lost residence nil-rate band, plus the higher rates of income tax, could lead to an effective tax rate of 90pc for some large estates if unused pensions are also included for deaths after April 2027.
As I've mentioned before, it is difficult to weigh up options until we have more details on exactly how the rules will work.
People who are in their late 70s or 80s already understandably feel frustrated by the lack of detail, as they might feel they have less time to act compared to those in the early years of retirement.
Lots of people have considered simply spending more in retirement as a way of avoiding the tax man taking a share of their pensions under the new rules. For you, that will mean paying income tax on the extra money you draw from your Sipp. What rate of tax you'll pay depends on your other taxable income.
Others who feel they really don't need the money, or already have more than enough to last them through retirement and potential care costs, are considering making use of gifting rules and available exemptions in their lifetimes. I've covered how making gifts from income can end up funding pension contributions for younger family members – and even get them tax relief in this previous article.
What action is best for you will of course depend on your personal situation and is an area where advice could help you and your beneficiaries save money.
My suggestion would be to wait until we've got more information on the rules and then consider getting some professional advice about your estate planning, especially when it comes to reviewing your wills and considering gifts.
This could help avoid any costly mistakes and make a huge difference to the amount your loved ones can inherit.
With best wishes,
–Charlene
Charlene Young is a pensions and savings expert at online investment platform AJ Bell. Her columns should not be taken as advice or as a personal recommendation, but as a starting point for readers to undertake their own further research.
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