How Pensions Can Help Protect Your Estate From Inheritance Tax

Pension is a major source of income after retirement. Also, regularly investing in your pension pot offers you a lot of benefits such as tax relief from the government and mandatory contributions from your employer. Talking about estate planning, a pension can play a significant role in protecting your family while safeguarding your savings. With a proper pension and inheritance tax planning, you can help your family to get the most out of your savings and assets. The less tax they have to pay, the more they can benefit from your estate. 

If you have been thinking about estate planning, you must also pay attention to your pension and try leveraging it for minimizing inheritance tax. Here we have brought a quick guide on how to use a pension to save inheritance tax. 

What is Inheritance Tax and How it Works?

After your demise, your beneficiaries will be charged a certain amount on the different items in your estate such as money, property, and other belongings. This amount is known as Inheritance tax. The inheritance tax depends on the total value of your estate and your beneficiaries. It is often considered as the “most hated” tax.

The standard limit for inheritance tax is £325,000. If your estate items are not more than this value, you don’t need to pay inheritance tax. Also, if your assets are worth more, but you give everything to your spouse, a charity, or civil partner inheritance tax won’t apply. However, when you have an estate worth a large value and don’t want to leave it to your spouse, a charity or civil partner, you will be charged an inheritance tax of 40% on anything having a value more than £325,000.

For instance, suppose your assets are worth £600,000, and you want to leave it to your cousin, inheritance tax charges will be applied to this. 

How are Pensions Helpful to Save Inheritance Tax? 

Pensions don’t sit inside your estate and will not be counted in your inheritance tax threshold after your demise. Therefore, pensions prove to be an excellent way of leaving your savings to your family and loved ones, while ensuring they get most of it. However, certain conditions may be applied depending on your age when you die and the type of pension pot you have. 

Let us talk about different types of pension and their use in inheritance tax planning. 

For a defined contribution pension, it is relatively easy to leave your money to your beneficiaries. If you have this type of pension and die before the age of 75 without taking benefits of your pension, your beneficiaries can claim your entire pension pot tax-free, within two years. 

Also, if you die at the age of over 75, your defined contribution pension will not be charged any inheritance tax, but your beneficiaries will need to pay income tax at the usual rate. 

Talking about drawdown pensions, when you die before the age of 75 and have already taken benefits of your pension through the drawdown option, your beneficiaries can choose to receive drawdown payments tax-free or access your pension pot as a tax-free lump sum. In this case, beneficiaries can also opt to use the pension amount to buy an annuity without having to pay tax on payments. 

For defined benefit pension or annuity holders, it may be complicated to pass the savings on to the beneficiaries. If you have this pension and you haven’t died and retired before the age of 75 years of age your beneficiaries will usually get a tax-free lump sum.

On a Final Note!

You can receive a lot more IHT benefits if you choose the right type of pension pot and do proper estate planning. Ensure that your loved ones can receive your pension in a hassle-free way after your demise. For this, you have to follow every step, including consultation with a financial planner, a thorough pension review, and so on.