Keep it in the family with tax-smart estate planning

At a glance

  • You can’t take it with you when you go, so what’s the best way to pass money and assets on – while paying the least amount of Inheritance Tax and protecting your assets from an uncertain future?
  • Make full use of your pensions and all of your tax allowances; it’s fundamental to family-friendly estate planning.
  • Your financial adviser can help you keep more of your money in the family by thinking ahead.

There comes a point in life when we start to think about what will happen after we’re gone. We all want to do the right thing for our families and loved ones, both now and when we’re no longer around.

How can we leave our family, especially our children, better off and more financially secure?

But at the same time as thinking about the hereafter, we need to be thinking about the here-and-now. Later-life and legacy planning can feel like being pulled in all directions. You may want to help your family members right now, especially with the squeeze on household budgets.

You also owe it to yourself to make sure you have enough money to last throughout your retirement. After all, you deserve to feel financially secure as you get older and you may also want to find the most tax-efficient way to pass a legacy on to your loved ones once you’ve gone.

That’s quite a lot to juggle. But with careful financial planning and advice that considers the long-term financial health of your whole family, you might be surprised how much you can do.

The power of planning ahead for Inheritance Tax

The first step in making sure that your loved ones get the best – and the most – from the assets you leave is to start Inheritance Tax (IHT) planning. IHT is the tax paid on your estate when you die. An estate includes money and investments, property, and valuable possessions. The less your estate is valued at, the less IHT your relatives will ultimately pay.

Not everyone will need to pay IHT, since your estate has to be worth more than £325,000. This tax-free threshold is known as the nil-rate band (NRB). There’s also a main-residence nil-rate band, of £175,000, if you pass your own home on to a direct descendant. If you’re able to utilise both those thresholds, you’re already able to pass on £500,000 tax-free.

Since IHT is charged at 40%, it’s vital to plan ahead to avoid making a big dent in the amount of money you’ll eventually pass on. Between April and November 2023, the Government received £5.2 billion in IHT.1 And with the IHT tax-free thresholds frozen until 2027/28, more of us may find ourselves liable.

And no-one wants HMRC to be their biggest beneficiary.

How you can pass your pension on, tax-free

When it comes to legacy planning, many people think about putting assets into trusts, or passing on property. But pensions also play a much more central role than they used to, because as far as IHT is concerned, your pensions generally sit outside your estate.

What happens to your pensions when you die?

As mentioned above, pensions are generally free from IHT on death, although there are certain schemes and situations where IHT can be payable so it is always wise to check.

If you die before you turn 75 depending on the options available in each scheme, your beneficiaries will generally have the option to take an income from the remaining funds, a lump sum or a combination of the two. Generally these will be paid free from tax, although there are limits on the amount that can be accessed tax free as a lump sum. Different rules apply to income on death from a final salary pension scheme.

If you die after turning 75, your beneficiaries will be charged Income Tax when they draw out the funds, either as a lump sum or as an income. This can give flexibility to spread any tax over multiple tax years, because Income Tax is paid at their marginal rate.

Money remaining in the pension pot itself will remain free of Inheritance Tax on the member’s death even after age 75, however if taken out as a lump sum it will now be part of the beneficiaries estate.

Making the most of ISAs

If you’re planning to pass on as much of your pension as possible, you’ll need to consider where else you get your income from in retirement.

You could draw on any tax-efficient ISAs you have. It’s important to remember however, that while ISAs can shelter you from paying Income Tax and Capital Gains Tax (CGT), any money left in your ISAs will be counted as part of your estate again after you die, so they may increase your IHT liability.

Get into a regular gifting habit

The tax system is also your friend when it comes to helping younger generations while you’re still alive. You’re allowed to make a total of £3,000 worth of gifts each tax year without them being added to the value of your estate (and you can use the previous year’s allowance, if you haven’t already, provided you use it first).

Similarly, small gifts of up to £250 can be made, free of IHT during a tax year to anybody who hasn’t also benefited from your £3,000 annual exemption. Gifting while you’re still alive is a great way to look after your family and reduce the size of your estate, so build it into your end-of-year tax planning, if you can afford to.

Larger gifts, which exceed the annual exemptions, can also be made to your loved ones. These are generally treated as Potentially Exempt Transfers (PETs) and are free of IHT after seven years.

It’s like leaving people some of their inheritance – while you’re still around to watch them enjoying it! And on a practical note, it’s worth keeping a record of any gifts in case you or your beneficiaries need to provide paperwork to HMRC.

Instead of making a direct gift to your children or grandchildren, you can make your money work even harder by putting the money into a children’s pension. This is a real win-win, as you reduce the size of your estate – and get the tax relief on pension contributions making your gift worth even more.

Practical, sensitive advice

It can feel uncomfortable to be planning what happens after you die, and some decisions can raise mixed emotions. Getting the right level of support and advice from a financial adviser can really help you make the right decisions. There’s a lot to get your head around – from the wide range of options available, updates to tax rules that you may not be aware of, to the complexity of certain aspects of IHT, as well as the emotional challenge of considering what to leave to whom.

Getting advice that you can trust helps strike the right balance between living the life that you want today, and helping your family live the life they aspire to tomorrow. Even if you’re not around to see it.

Need some sound, sensitive advice on estate planning? Get in touch with us today.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.

Trusts are not regulated by the Financial Conduct Authority.

Although anyone can contribute to a pension for a child only the parent/legal guardian can open the pension for them.

Sources, 21 December 2023

SJP Approved 31/01/2024