Estate planning opportunities from pension pot tax change

The chancellor’s announcement to scrap a 55% tax charge on unspent pension pots has been hailed as a new way to save inheritance tax.

The change is specific to drawdown pensions where contributions build up in a pot. Currently, if a person is drawing such a pension and dies under the age of 75 then the pot remaining is taxed at 55% unless the funds pass to a spouse or children under the age of 23. If a person dies after 75 without having touched their pension pot it is also taxed at 55%.

But from April 2015 all pensions, whether in drawdown or not, can be inherited free of tax, thus avoiding this hefty charge. There is a limit of £1.25 million on the overall value of the pot but it could be a very attractive way of passing money to younger generations.

However some reports have called the change an end to the “death tax”, but it is wrong to conclude it spells the end of inheritance tax. Unfortunately that is not the case!

Inheritance tax remains unchanged. It is charged at 40% on the value of an estate above the then applicable nil rate band (currently £325,000), with the potential to double that threshold for spouses and civil partners. Combined with the pension pot changes there is the potential for estate planning to mitigate the inheritance tax charge on death, while continuing to pay into your pension and ultimately to benefit your children.