With all of the current press activity around pension taxation and the impact it can have on certain members of the medical profession, pension savers currently thinking about end-of-year tax planning shouldn’t forget about inheritance tax. For many doctors who have worked less than full time, or who may have had breaks in their career, there is a little utilised opportunity to use private pension arrangements to plan for this eventuality and it’s important not to overlook it. Equally there is may be a great opportunity to utilise a spouse or partners annual allowance for this purpose. way.
This is because most pensions have an unusual status under the inheritance tax rules. They don’t count towards the total amount you are allowed to pass on to heirs without any tax being due. For this reason, defined contribution pension savings are a valuable inheritance tax planning tool (income from a final salary pension or an annuity, by contrast, usually dies with you or your spouse).
The bottom line is that savings you have invested in a defined contribution pension plan – a stakeholder or personal pension, for example, or a company pension scheme set up in this way – can be bequeathed to anyone you choose. Importantly, you do this by completing an “expression of wishes” or “nomination” form with your pension provider, rather than through your will.
It doesn’t matter whether you’ve started taking money from your NHS pension savings using an income drawdown plan or whether you’re still building up your fund. Either way, the money won’t be considered as part of your estate for inheritance tax purposes.
Your beneficiaries may still have to pay some tax. Usually, if you die before the age of 75, your pension savings can be passed on completely tax-free; your beneficiaries can use the money in whatever way they wish with no tax to pay as long as they take it within two years. By contrast, if you die at age 75 or over, your beneficiaries normally pay income tax on what they receive at their highest marginal rate of income tax. A basic-rate taxpayer would pay 20 per cent on the cash, for example, while a higher-rate taxpayer would pay 40 per cent.
The way the system is set up has some important implications for inheritance tax planning. First, as you’re thinking about how to support yourself in retirement, it makes sense, from an inheritance tax point of view at least, to run down savings such as money in an individual savings account (Isa) before you start using your pension money. Almost all other forms of savings do count towards your estate, so reducing them and leaving your pension in tax could be a way to reduce the inheritance tax bill your heirs receive.
The second action point here is to discuss tax planning with your heirs. If you’re passing on pension savings after your 75th birthday, they may need to think carefully about how to take the money in order to manage their income tax bill. It may not make sense to take it all in one go.
This is because inheriting pension cash could push them into a higher tax band, exposing them to more tax than necessary. Higher-rate taxpayers need to be especially cautious here. If they receive enough to take their income over £100,000 a year, they start to lose their personal allowance under the income tax rules, effectively exposing themselves to a 60 per cent tax rate on part of the pension inheritance.
By contrast, non-taxpayers will pay nothing on inherited pension savings, even from someone over the age of 75. You could choose to take advantage of this by leaving money to grandchildren – cash that might help with university costs or even a deposit on a first home, for example. If they’re non-earners and you leave them a sum below the income threshold at which tax first becomes payable – currently £11,850 but rising to £12,500 on 6 April – they’ll pay no tax at all.
The Financial Conduct Authority does not regulate Inheritance Tax Advice.
Content correct at time of writing and is intended for general information only and should not be construed as advice.