Whilst the start of this tax year sees the new main residence nil rate band (MRNRB) come into effect for inheritance tax (IHT) planning purposes, the recent changes to pension rules have affected the IHT planning world in perhaps a more radical way.
The beginning of this tax year sees the introduction of a new inheritance tax planning allowance – the family home allowance, or main residence nil rate band - which is being phased in over the next four years.
The main residence nil rate band (MRNRB) over the next four years, will be worth:
- £100,000 in 2017/18
- £125,000 in 2018/19
- £150,000 in 2019/20
- £175,000 in 2020/21
So by 2020/21, you could leave an estate worth £500,000 tax-free (£325,000 nil rate band plus £175,000 MRNRB), or couples could leave £1m of their estate IHT-free. Remember though that the MRNRB only applies to one main residential property, not to any second homes, and also only if it is left to direct descendants, such as a child or grandchild.
This is obviously welcome, although somewhat overly complicated. However, the fairly recent changes to pension rules have perhaps more truly revolutionised the way people should be thinking about estate planning and inheritance tax (IHT).
Currently, most people think of pensions as providing retirement income. But the new pension rules now mean you should also consider pensions in terms of IHT planning, indeed possibly spending as little of your pension pot as possible.
Before the new pension rules were introduced, pension funds were taxed at a punitive rate - up to 55% on death after 75 or after having taken tax-free cash or an income. Because of this, pensions were usually spent before the other options, eg Isas, as pensions were likely to be subject to more tax on death.
All this changed in April 2015. Now, pension funds are normally completely tax free on death before age 75. In addition to no IHT liability, your beneficiaries can also take all the money free of income tax, or keep the fund invested and take the money out as and when they like, free of income and capital gains tax. If you die after age 75, there is still usually no IHT, but your beneficiaries then inherit the pension and are charged their marginal rate of income tax on any withdrawals they make.
Because of this, pensions have now become an extremely effective IHT planning tool. There are circumstances under which IHT could still be payable; for example, if pension contributions have been paid while in ill health or within two years of death. However, overall this is a major transformation: instead of just using your pension to fund your retirement, it can now also be seen as an IHT wrapper.
This means you should now consider whether your retirement and your income should be funded by other means than your pension. Should you spend taxable investments first, Isas next and pension pots only as a last resort?
Income paid from Isas, for example is free of tax, whereas your pension will attract tax at your marginal rate – indeed, your pension may even take you into a higher tax bracket. And on death, Isa savings will be counted as part of your estate, unlike any unused pensions, which can be passed on tax-free before the age of 75.
Obviously, before you start the IHT planning process, you should look to ensure that you will be financially secure during your retirement. Whilst minimising tax (both in life and death) is important, you need to make sure that you have enough to live on during your retirement first.
This is where it makes sense to talk to your financial adviser. He or she will be able to help by providing a genuine insight into the latest tax planning options - and can work with you to develop a strategic plan that takes into account your own personal objectives and circumstances.
In this way, you can have a secure, comfortable retirement, whilst minimising taxes and maximising legacies for your beneficiaries.
To discuss your retirement and IHT planning, talk to Kellands.