Monthly Archives

September 2025

Sep 25
0

Pensions and IHT

By | Financial Planning

As announced in the 2024 Budget, from 6th April 2027, the value of most death benefits and unused pension funds held at date of death will form part of an individual’s estate for Inheritance Tax (IHT) purposes.

The draft rules are in stark contrast to the tax-advantaged position that currently applies. At present, unused pension funds, or remaining pension funds held in Flexi-Access Drawdown, can be passed to beneficiaries at the discretion of the pension trustees, outside of their estate for IHT purposes. This effectively allows the passing of unused pensions through generations and is an effective estate planning tool.

The first round of industry consultation following the 2024 Budget has now concluded. Further consultation is ongoing, although there is little chance of any substantive change to the draft legislation from this point. Those holding unused pension funds should, therefore, take the opportunity to review their position to determine whether any action is necessary in advance of April 2027.

Spousal exemption

The first round of consultation confirmed that pension benefits paid to a spouse or civil partner will remain exempt from IHT; however, just as is currently the case with assets other than pensions, a liability to IHT may arise on the second of a married couple to pass. This exemption does not apply to unmarried partners and could lead to an unexpected liability to IHT in the event of death of an unmarried individual, whose estate would not benefit from the usual spousal exemptions.

The draft legislation has further clarified the rules on Death in Service payments, which will also remain exempt from IHT from April 2027.

Potential 67% tax charge on inherited pensions

Not only will unused pension fund death benefits be subject to IHT, the existing tax rules for those also drawing death benefits from a beneficiary’s drawdown pot will remain in place. If the pension holder dies before the age of 75, whilst IHT could apply depending on the value of the estate, the beneficiary of pension benefits can draw down on the inherited pot without income tax applying to the payments.

The situation is different where a pension holder dies after the age of 75, as the beneficiary is taxed at their marginal rate of income tax on monies drawn from the pension. From April 2027, the value of the pension could potentially be subject to IHT at 40%, and funds drawn from the inherited pension could then also be subject to income tax up to 45% in the hands of the beneficiary.

Take the following example, which assumes you were to inherit a pension pot valued at £100,000 from someone who died after the age of 75, and all available nil-rate bands for IHT have already been used. The table shows the position where a beneficiary is either a Basic, Higher or Additional Rate Taxpayer, and in the case of Basic and Higher Rate taxpayers, the pension funds withdrawn are within the respective tax bands.

The above examples do not consider the potential impact of an additional tax liability if the Main Residence Band – which applies if you leave a property to your children or grandchildren – becomes tapered. This occurs for estates valued at between £2m and £2.35m for an individual or £2.7m for a married couple. In this instance, the effective rate of tax payable by an additional rate taxpayer, who receives pension death benefits, could reach 87%.

Clarification for Personal Representatives

The original proposals gave pension scheme administrators significant reporting and payment responsibilities, but following the first round of consultation, the responsibility to account and pay the correct amount of IHT falls on the Personal Representatives dealing with the estate.

Personal Representatives will need to contact the pension scheme to ascertain the value of the pension for reporting purposes, and pension scheme administrators will need to provide this within four weeks of a request. If IHT is due, Personal Representatives will need to calculate the IHT liability attributable to each pension and notify the pension scheme and beneficiaries.

Where the pension death benefits are free of IHT, either by virtue of spousal exemption or where the total value of the estate including pensions is below the Nil Rate Bands, pension trustees can pay benefits without delay.

If IHT is due, Personal Representatives can ask the pension scheme to pay tax directly to HMRC to settle the IHT liability, or they can pay the IHT due from other assets within the estate.

Despite this clarification, dealing with an estate containing unused pensions will become significantly more challenging after April 2027, and given the added complexity, it may well be worth considering who is appointed as Executor of your Will. Of course, Executors could seek professional legal and financial advice in dealing with aspects of an estate in relation to pensions.

Consider the impact of the new rules

For those with unused pension funds, now is the time to review pension values to determine whether the change in rules will alter the potential IHT liability on your estate from April 2027. If so, action can be taken to mitigate the additional IHT that could become payable. For example, you could consider taking benefits from a pension and gifting the Tax-free Cash element, drawing additional pension income and making gifts out of surplus income, or purchase an annuity.

As the pension value will simply be treated as another asset from April 2027, you could also consider planning with other assets held outside of a pension, which could be structured to reduce the impact of IHT. The most appropriate solution will depend on the precise composition of assets held, family circumstances and financial objectives. This is why seeking bespoke and tailored financial planning advice will be key to adopting an effective strategy.

The advisers at FAS always take a holistic approach to financial planning. We look at a wide range of aspects of an individual’s financial position, and as an independent firm, we can consider solutions from across the marketplace without restriction. If you have questions relating to the changes to pension death benefits, speak to one of our experienced advisers who will be happy to help.

Sep 18
0

Are Your Financial Affairs Really in Order?

By | Financial Planning

When measuring the effectiveness of any financial plan, it would be tempting to simply focus on factors such as investment performance, tax efficiency, and ease of administration. Failing to consider the wider implications of unforeseen scenarios, such as death or loss of mental capacity can, however, place the best laid financial plans at risk. We look at the importance of writing a will, making an expression of wish over existing personal pension death benefits, and preparing a Lasting Power of Attorney.

Set out your wishes

Writing a will ensures your wishes are carried out the way you intend. Leaving a will that states clearly who should receive your possessions and property when you die can prevent unnecessary distress for your loved ones.

Everyone should consider making a will; however, anyone who has children or other family members that depend on them financially should view this as a vital action to take. Likewise, if you would like to leave possessions to people who are not part of your immediate family, preparing a will is the only way to ensure your executors follow your wishes.

If you die without leaving a valid will – known as dying “intestate” – the law determines who inherits your assets. This may mean that loved ones are unprotected, and other family members excluded from benefitting from your estate. As more couples now co-habit, it is important to understand the laws of intestacy can leave partners who are not married or in a civil partnership financially vulnerable, as they will not be legally entitled to anything under the intestacy laws, irrespective of how long the relationship has lasted. Likewise, those living in blended families are particularly at risk, as the law may not divide assets fairly.

After making a will, it is important to review the wording of a will periodically, to make sure that the will reflects changes in family makeup or circumstances.

Pension Expression of Wish

In conjunction with preparing a will, it is also important to ensure that an Expression of Wish for any existing pension arrangements has been prepared and is up to date. An Expression of Wish lets the individual set out who they would prefer the money to go to and in what proportions, in the event of their death.

It is a common misconception that a residual pension will pass in accordance with an individual’s will. This is not the case, as the pension trustees will decide who will receive the pension death benefits. The trustees are not obliged to follow the wish expressed by the pension holder; they will, however, take such wishes into account when reaching a decision.

Lasting Power of Attorney

According to Age UK, there are an estimated 982,000 people who are living with dementia in the UK, with this number expected to rise to 1.4 million by 2040. These sad statistics underline the importance of considering who would manage your affairs if you were no longer able to make decisions.

Preparing a Lasting Power of Attorney (LPA) can ensure your loved ones can make important decisions about your health and your financial assets on your behalf, should you become incapacitated through ill health or accident.

An LPA is a legal document that lets you appoint individuals you trust to make decisions on your behalf, should you become unable to make those decisions for yourself in the future. There are two LPAs that can be prepared, one covering Property & Affairs (e.g., your home and assets) and the other covering your Health & Welfare (such as care and medical treatment).

You can choose to set up one or both types of LPA, and you can nominate the same person or elect to have different attorneys for each. You do not instantly lose control of the decisions that affect you when preparing an LPA. For the Property & Affairs LPA, you can be specific about when the attorney can take control when preparing the LPA. In the case of the Health & Welfare LPA, this can only be used when an individual loses mental capacity. All LPAs must be registered at the Office of the Public Guardian, a government body, before they can be used.

If you lose mental capacity without an LPA in place, someone who wishes to act on your behalf may need to apply to the Court of Protection to be appointed as your ‘deputy’, who will have similar powers and responsibilities as someone appointed under an LPA.

The process of making a Court of Protection application is long-winded, with significant delays before an Order is made. Furthermore, the Court will decide on who is appointed as deputy, which may not be someone you would choose if you had capacity.

Failing to prepare an LPA can cause family members significant distress if you lose capacity to make decisions, and lead to financial vulnerability. Bank and investment accounts may be frozen, leading to difficulties in dealing with day-to-day financial matters, and those with complex financial affairs or business owners are at even greater financial risk should they lose mental capacity.

Take the time to review your affairs

Take a moment to review your affairs and consider what would happen in the event of your death, or loss of mental capacity. Neither situation is something we wish to contemplate; however, failing to prepare a will and LPA could cause loved ones emotional and financial difficulties, and undermine financial planning decisions.

As part of our holistic planning service, we remind our clients to make a will, or review an existing will, refresh their Expression of Wish, and make an LPA at our regular financial reviews. Speak to one of the team to discuss whether your affairs are in order.

Sep 04
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Using Trusts for lifetime gifts

By | Financial Planning

More people than ever are considering the potential impact of Inheritance Tax (IHT) on their wealth and looking for ways to protect assets from tax on death. Amongst a range of different options, gifting assets away to family members is one of the simplest methods of reducing the value of your potential estate, mitigating an IHT liability, and transferring family wealth to the next generation.

Making outright gifts is, however, not always possible or the gift could result in unintended consequences. If the beneficiary of the gift is under the age of eighteen, they cannot receive gifts directly. Grandparents gifting larger sums to their children could inadvertently add to their children’s IHT concerns due to the value of their own assets. We regularly see situations where family members are gifted funds to help purchase a home, only for a relationship to break down, leading to dilution of family wealth through a divorce settlement.

Instead of gifting funds directly, settling money in Trust can be an effective planning tool that helps protect family wealth and avoids the pitfalls that can arise when making outright lifetime gifts.

There are a range of different Trusts that individuals can establish, with an Absolute (or Bare) Trust being the simplest. This is where funds in Trust benefit a single individual, usually a minor, who accedes to the Trust capital at the age of eighteen. A more flexible arrangement is, however, often preferred, where the donor can retain control over when assets held in Trust are paid to beneficiaries.

Increased flexibility

Discretionary Trusts provide this flexibility, as the Trust wording allows the funds held in Trust to be paid to anyone within a pool of potential beneficiaries. Trust wording will often allow children, grandchildren, and great-grandchildren of the settlor to benefit, although it could also include other named beneficiaries. The Trust is flexible in that it allows the Trustees to decide who receives funds from the Trust, and when. The following provides an example of how gifting into a Discretionary Trust would work in practice, to protect family wealth.

Mr & Mrs Smith own property and other assets valued at £2.5m and wish to gift funds across generations of their family. They have not undertaken any lifetime gifting previously. Mr & Mrs Smith each gift £325,000 into a Discretionary Trust, which avoids any immediate Inheritance Tax charge as this is within their Nil Rate Bands. Mr & Mrs Smith appoint themselves as Trustees, to retain control over the Trust assets, but also appoint their daughter as an additional Trustee, to ensure continuity in the event of death of one or more of them.

The potential beneficiaries of the Trust are any of Mr & Mrs Smith’s children and grandchildren. The Trustees invest the Trust funds in a diversified managed investment portfolio and future growth is therefore outside of the Smith’s own estates. Beneficiaries receive Trust capital at various intervals, to help grandchildren through further education, and to provide one older grandchild with a deposit for their first home. The remaining funds held in Trust continue to grow over the longer term, enabling future generations of the family to benefit. After seven years, the gift into Trust falls outside of Mr & Mrs Smith’s estate for Inheritance Tax purposes.

Wider planning options

When using a Discretionary Trust, the Settlor (i.e. the person setting up the Trust) cannot benefit from the Trust, if the gift is to be effective for IHT planning. There are, however, a range of different options that can provide the Settlor with access to the funds gifted into Trust, whilst ensuring that the funds held in Trust grow outside of their estate.

Discretionary Gift Trust arrangements allow the Settlor to receive a regular stream of capital payments from the Trust, and the value of the gift for IHT purposes may be subject to a discount, based on the age and health of the Settlor. Loan Trusts are a further alternative that can be effective in certain circumstances. The Settlor lends funds to the Trust, which can be repaid to the Settlor if required, whilst growth in the value of the Trust capital is outside of the Settlor’s estate.

Tax considerations

Discretionary Trusts can be powerful tools when it comes to protecting family wealth. They are, however, subject to a more punitive tax regime than individuals, with interest and savings income taxed at 45% and dividends at 39.35%. It is therefore important to consider the most appropriate method of establishing the Trust and arranging the Trust assets, to avoid unnecessary tax liabilities.

Most transfers into discretionary Trusts are Chargeable Lifetime Transfers (CLTs). Unlike gifts to individuals, which are Potentially Exempt Transfers, CLTs may give rise to an immediate IHT liability if the value of gifts exceeds the Nil Rate Band. Discretionary Trusts are subject to a liability to IHT on the 10th anniversary of the creation of the Trust and each 10-year anniversary thereafter, and a potential IHT charge is also payable when assets leave the Trust. These charges are, however, modest when compared to the rate of IHT charged on death.

Administrative matters

In addition to tax considerations, Trustees will also need to ensure that they properly administer the Trust, including registering the Trust with HMRC, via the Online Registration Service, and filing annual tax returns as required. It is, therefore, essential that Trustees keep good records and seek advice from an Accountant or Solicitor. Where FAS provide Trustees with investment advice, we can provide detailed reports of income and capital events for each tax year, to simplify the reporting process.

The need for tailored advice

It is important to consider Trust planning as one of a range of options available which can help mitigate a potential IHT liability. Each option has benefits and drawbacks and therefore selecting the right path, or paths to take, will depend on your individual circumstances. Our experienced advisers can show you examples of various Trust planning advice we have given to clients, to help you select the right option. Speak to one of the team to start a conversation.