Save Inheritance Tax With Pension Funds

Most pension funds are usually set up as a discretionary trust.  This means the pension benefts are held by pension scheme trustees in trust for you for when you retire an take lump sum and income benefits or pass away and death benefts are paid to loved ones.

Because pensions funds are usually discretionary trusts, they are outside your estate for estate reporting and inheritance tax calculations.  Most schemes are inheritance tax free. 

Other Tax Advantages Include:

• Income Tax Relief on your pension contributions, business expenses relief for employers paying into your scheme.
• Income Tax Free for any income earned by your pension fund investments.
• Capital Gains Tax Free on any growth of the fund.

Who Can Save In Pensions?

• Virtually all of us are allowed to save in pension funds.
• Working/Self Employed:  Maximum yearly contributions based upon the lower of your gross earnings and £60,000.  This means that if you earn £25,000 pa, the maximum you and your employer can pay in this year is £25,000 gross.  If you earn £80,000 pa, you and your employer are then capped at £60,000 gross maximum annual pension allowance.
• No earnings? We can all still pay into pensions:
  • Children:  even a new born baby with no earned income can have pension contributions paid for them and get tax relief (even though they are non-taxpayers).  Maximum £3,600 pa gross (you pay in £2,880 net and 20% tax relief is added.
  • Pensioners and other none workers with no earned income can also pay in pension contributions up to £3,600 pa gross.

It therefore makes sense to save in pensions, even if you are no longer working, to build up an inheritance tax free fund for you and your loved ones.

Pensions and Death – Lump Sum Death Benefits

As mentioned above, pension funds on death are usually IHT free as they are usually set up as discretionary trusts but there are some exceptions:

Lump pension benefits paid on death may form part of the estate for IHT if they are not in trust such as the following:

• Section 32 Buy-out Plans (usually a transfer of an old company scheme into an older style pension in your own name).
• Old style Retirement Annuity Contracts (sometimes called RACs, sometime Section 226 or Section 620 pensions).
• Occupational (company) pension schemes not in discretionary trust.
• Statutory Schemes (set up by law/statute e.g.  Section 32 of the Financial Aact 1981 established Section 32 Buy Outs) and any other Statutory Scheme set up before 1989 such as the Civil Service Scheme and other public service schemes that were established before 14 March 1989 and do not have to comply with the Income and Corporation Taxes Act nor register with the then Pensions Schemes Office PSO (part of HMRC now) as their own pension scheme rules were established by passing a law (Statute) to set them up.

The above schemes are not in trust and therefore, no trustees have discretion over who should receive the benefits on death.  Benefits are paid directly to the estate of the deceased or a named individual although there will be no IHT payable where these lump sums are paid to the spouse or civil partner of the deceased because of the IHT transfer between spouses exemption.

Beware ‘2 Year Rule’ on Pensions, Ill-health and Death

From April 2015, some actions with your pension whilst in poor health could result in IHT becoming payable on death.  This is to do with a ‘transfer of value’ away from your estate meaning you estate and therefore, IHT would be lower resulting in a tax loss to HMRC or you are deliberately taking action via your pension scheme to reduce IHT when you are in ill-health.

Transfers of Value when in Ill-Health and Death: HMRC requires the execuors to complete form IHT 409 for a deceased estate regarding actions on pensions within 2 years of death:

• If transferred pension benefits to another scheme.
• If paid pension contributions.
• By putting pension funds in trust that were not already set up as a discretionary trust to try and avoid them being included in the estate for IHT e.g.  see above notes on Section 32 Buy Outs and Retirement Annuity Contracts (RACs).

Done In Good Faith?  The value transferred will have no value for the estate and IHT calculation if the deceased was in normal health at the time of the transfer with HMRC assuming someone was in normal health if they survive for two years but executors must still report it using IHT 409 and HMRC will then treat it based upon the individual facts of each case.

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