Axing inheritance tax (IHT) would be hugely popular among millions of families who hate the idea of paying 40 percent of their household wealth to HMRC when they die. Many felt it would give the Conservative Party a major boost ahead of the general election, giving Hunt strong grounds to act.
Callum McGoldrick, researcher at the TaxPayers’ Alliance, said the Tories have been talking about scrapping inheritance tax for years but this is its last chance before the election.
He said abolishing it could increase tax revenues by encouraging growth. “Unfortunately the Treasury doesn’t account for this possibility.”
Now Hunt looks set to dash hopes of reform by shelving plans to cut IHT tomorrow and knock 1p or 2p off either income tax or National Insurance instead.
This means families are on their own and will have to pull out all the stops to reduce their inheritance tax liability.
Luckily, many have a secret weapon that they don’t even know about: their pension.
Pensions offer a host of tax advantages but one of the most valuable comes right at the end, as you can pass any unused pot to loved ones free of inheritance tax.
Many pensioners seize the opportunity to slash their family’s potential IHT liability, but most do not even know this tax break exists and risk missing out as a result.
New research shows that almost two thirds of Britons are unaware that pensions usually sit outside their estate, and typically will not count towards their IHT liability when they die, according to the research from PensionBee.
Among those who are aware, as many as half plan to take advantage by transferring money into their pension to save tax, which shows how valuable this is.
By shifting wealth into a pension they can also make the most of another huge pension break, by claiming tax relief on contributions.
Money invested in a pension rolls up free of tax but withdrawals are added to your total earnings for the year with the total subject to income tax.
Pension withdrawals instantly fall back into your estate at which point they may become subject to IHT, too. This includes any tax-free cash.
Hopes that Chancellor Jeremy Hunt would scrap IHT or make it less punitive in his spring Budget on March 6 are fading, which makes it even more important that people reduce their potential exposure.
Inheritance tax is charged on the value of an estate above £325,000. This is known as the nil-rate band and hasn’t increased since 2009, dragging more people into HMRC’s net as property and investment values rise.
Under the £175,000 main residence allowance, people can also pass on wealth tied up in the family home to children or grandchildren.
This lift the total potential IHT exemption to £500,000 per person, rising to £1million for married couples or civil partners. Any assets are do become liable to IHT is taxed at a punitive rate of 40 per cent.
Becky O’Connor, director of public affairs at PensionBee, said pensions offer highly valuable IHT-planning benefits, but these regularly go unused. “As a result, estate beneficiaries could ultimately miss out or pay more tax on inherited wealth than necessary.”
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Retirees who are aware of this pensions tax perk often spend retirement savings and investments that are subject to IHT first, including their Isas, and leave their pension to last.
Inherited pensions may not escape tax altogether, though. How they are treated normally depends on how old the policyholder is when they die.
There are one or two exceptions where your pension may incur IHT. If you make pension contributions while in poor health they could be subject to IHT if you die within two years. This prevents people from transferring wealth into a pension knowing they are going to die and never use the money.
If someone uses their pension to buy an annuity, and this pays a death benefit or guaranteed lump sum when they die, this may also be subject to IHT.
If a pension policyholder dies before age 75, their pensions can be passed on entirely free of tax. However, if they die afterwards the inherited pension will be added to beneficiaries’ total earnings for that financial year, and taxed at their marginal rate.
These days most retirees prefer to leave their money invested in drawdown and O’Connor said this may be the best way option for IHT planning. “Drawdown allows you to keep your pension invested while taking withdrawals as needed, potentially reducing the size of your estate subject to IHT,” O’Connor said.
Andrew Tully, head of technical services at Canada Life, said other ways of cutting IHT exposure include making gifts during your lifetime, setting up trusts, or making use of exemptions and reliefs.
