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Pensions as an Inheritance Tax (IHT) planning tool - Making pension contributions for others By Terence Mope
Many IHT planning strategies involve making significant capital payments with the sole objective of reducing the taxable estate. Clients are sometimes reluctant to make outright gifts as, in their opinion, the ‘recipients’ (mainly children and grandchildren) spend the money on bigger homes, expensive cars or expensive holidays! An alternative to ensure that the money is not spent but wisely invested is to make use of the tax advantages offered by contributions to registered pension schemes by making pension contribution for recipients in order to reduce your taxable estate. t a time when resources are scarcer for young adults, IHT planning strategies that will benefit recipients by relieving them of the urgent need to fund their pensions should be given great consideration. Contrary to the widely held belief that gross annual contributions to authorised pension schemes for recipients is capped at £3,600, contributions can be as high as the annual allowance depending on the circumstances. The £3,600 limit only applies where the recipient has no taxable income for the year. Where the recipient is in employment with earnings of say £40,000 or more per annum, the opportunities are substantial as highlighted below.
l The estate of the donor reduces by
the amount of the gift made in the form of contributions potentially resulting in a 40% saving on IHT provided it falls within the normal expenditure out of income rules so that it does not form part of the 7 year rule; l Basic rate relief at source from HMRC will effectively increase the gift by 25%; l Where the recipient is a higher or additional rate tax payer, they may enjoy a relief of their tax liability of between 25% and 31.25% of the gift; l Tthe recipient’s pension fund enjoys tax advantaged growth as it suffers no income tax or capital gains tax charges; l Due to the rules for drawing down pensions, the recipient usually has no access to the gift until they attain minimum pension age which is currently 55 and scheduled to rise to 57 by 2028;
l Should the recipient die before age
75, tax-free death benefits (including lump sum) may be payable from the pension pot. l If the recipient dies after 75, the drawdown from the pension fund is taxed at the marginal rate of the recipient of the drawdown. Of course, consideration has to be given to the recipient’s pension lifetime allowance and the potential tax implications if their pension fund exceeds the lifetime allowance where there is a 55% tax charge if drawn as a lump sum or 25% tax charge if drawn in any other way, such as pension income or cash withdrawal. Normally, gifts are subject to a 7 year rule so that IHT is only avoided if the donor survives 7 years after making the gift. However, what is less know is that larger regular gifts made as part of your normal expenditure out of your income without affecting your standard of living are not subject to the 7 year rule and are exempt from IHT. This exemption does not apply to
FINANCE, BANKING & INSURANCE - Asian Voice & Gujarat Samachar 2018
gift made out of capital but presents a considerable tax planning opportunity as illustrated below with a donor having a surplus monthly income of £1,000 over a 10 year period. See chart below So: l If no action had been taken, the recipient will have received £72,000 assuming a 40% IHT rate; l By investing in a pension fund, the effects of the tax relief is that the value of the pension fund will be between £150,000 and £218,180 depending upon the tax bracket of the recipient. It should be noted that the illustration above does not take account of the growth of the investment (both income and capital gains) which will accumulate tax free in the pension fund but of course will be subject to charges from the pension fund provider. Clearly this is one way of reducing your penitential IHT liability. There are other possibilities. However, we would suggest that you see a professional adviser to consider ways of minimising your IHT liability taking your specific circumstances into account as doing nothing is not an option.
Terence Mope (ACCA) is a tax consultant with Chown Dewhurst LLP where Kaushik Desai is a principle. Contact: Tel 020 3283 4566 or email firstname.lastname@example.org
Finance Banking Insurance 2018 (Issue 18)