Inheritance Tax (IHT) has often been regarded as a voluntary tax. But with George Osborne freezing the threshold at £325,000 per person until 2019 and other loopholes being closed, now is the time to consider how you will leave as much money as possible to your loved ones.
IHT is payable at a rate of 40%, when a person’s estate is valued at above £325,000 or £650,000 for married couples and people in a civil partnership.
The traditional options for dealing with an IHT liability include:
- Writing a tax-efficient Will
- Using the annual gift exemption of £3,000
- Using the small gift exemption of £250 per person per year
- Other gifts, known as Potentially Exempt Transfers (PET)
- Investing in assets which qualify for Business Property Relief
- Arranging your investments in a tax-efficient way, which can mean the use of complex and sometimes expensive, trusts
All of these options reduce the amount of IHT payable. However, there is another route which is becoming more and more popular; the Whole of Life (WOL) insurance policy.
The principle is simple.
A married couple, or indeed one in a civil partnership, calculate the amount of IHT due on second death (remember that if a husband or wife leave their entire estate to each other, no IHT is payable on first death). Then a WOL insurance policy is taken out, with a sum assured equal to the IHT liability. Whilst this route doesn’t actually reduce the amount of IHT payable, it is a non-contentious and simple way of dealing with the problem. Furthermore, because the sum assured is payable on second death, it can be a surprisingly cost-effective.
“So how can my pension help?”
Using a WOL policy to pay any IHT due can be a very simple way of solving the problem as it doesn’t involve complex trust arrangements or giving money away.
Many wealthier retirees who have an IHT liability, also have small pensions which when turned into income will make little or no difference to their standard of living. Normally, from an IHT perspective, we wouldn’t recommend turning these into an income as unvested pensions are passed on to beneficiaries with no tax deducted. But, could these be put to better use to completely solve your IHT problem?
We believe they can. Let’s look at an example.
Mr and Mrs Lee are 65 and 63. Mr Lee is retiring and Mrs Lee has already finished work. Their combined state and work place pensions will provide a gross income of £24,000 per year, which is plenty to meet their outgoings. However, Mr Lee also has a small pension pot worth £30,000, which he doesn’t know what to do with as turning it into an income won’t make any significant difference to their standard of living.
Mr and Mrs Lee have saved hard over the years, been lucky with the property market and now have an estate valued at approximately £1 million. They want to leave their estate to each other when one of them dies and then to their two children equally. This means their children would currently have to pay an Inheritance Tax bill of around £140,000; something Mr and Mrs Lee are really not happy with and would like to avoid.
This is where Mr Lee’s small pension pot could help.
If Mr Lee buys a joint life Annuity, with a 10 year guarantee and a 100% spouse’s pension, this would provide an income, after tax, of approximately £100 per month. This is enough to buy a WOL policy with a sum assured sufficient to pay the IHT liability on second death and mean their children would benefit from the full value of the estate.
Of course everyone’s circumstances are different and this really is only an option if there is ‘spare’ pension capacity. Mr and Mrs Lee should also consider other ways of reducing their IHT liability, which would perhaps mean the WOL policy needed a lower sum assured and also how they would cope with any future increases in premiums.
However, the point is simple, if you have ‘spare’ pensions why not consider using the income they can generate to help with other areas of your financial planning such as dealing with an Inheritance Tax liability.
Do you have an Inheritance Tax liability?
The all-important small print (so important we we’ve included it in bold!)
The Financial Conduct Authority (FCA) does not regulate tax and trust planning and Will writing.
The value of investments can fall as well as rise. You may get less back than you invest.