COVERING THE IHT LIABILITY IN A PENSION

The changes to the IHT impact on unspent pension funds from April 2027 has led to a great deal of speculation about how best to mitigate the new liability that a significantly increased number of people will now have to deal with.

Many people who have saved into pensions over the years will now find they have a significantly increased IHT liability, while for some, there will now be an IHT liability they never expected to have.  These people will need help in navigating their way through the IHT waters.

One potential strategy is to use life insurance to fund the additional IHT that might arise. Cover could be obtained to offset the potential IHT liability arising on that part of the savings in excess of the available nil rate band (NRB), but a number of factors need to be considered when deciding whether this is an appropriate option.

The comparison, when looking at insuring the IHT liability in the pension, is whether the addition of the policy sum assured after considering the premiums paid, will provide a better position on death than just leaving the pension invested. The factors that will determine this are:-

• Future growth of the pension fund
• Life expectancy of the client
• Policy details – sum assured and premiums payable.

Example case study

Elaine is 65, in good health and has ‘unspent’ pension savings of £1m. She takes out a whole of life policy for a sum assured of £750,000 the premium for which is £16,500 per annum on a guaranteed basis. The premium is provided by withdrawals from the pension which means each withdrawal must be for £20,625 as Elaine is a basic rate taxpayer. Pension savings are assumed to grow by 4% p.a. net of charges and will be fully subject to IHT at 40% following Elaine’s death.

Projections suggest that the policy sum assured plus the value of the pension after IHT will provide a better outcome for the first 32 years (i.e. age 97) compared to just leaving the pension invested and deducting IHT on death. Thereafter the non-insured option will give the better outcome. The total amount withdrawn from the pension to pay the premiums will equal the policy sum assured after 36 years.

The premium is based on ordinary rates with Elaine’s life expectancy being 23 years (based on the Office For National Statistics Census 2021). So, in Elaine’s case insuring the estimated IHT liability on the pension does give a better outcome if she dies any time up to age 97.

The policy can be written in trust and enables the IHT due on Elaine’s death to be paid without the need to sell any of the pension assets. The pension can then be distributed to the beneficiaries, with an income tax deduction at the beneficiaries marginal rates if Elaine was over 75 when she died.

The premiums paid for the policy could be covered by the annual and/or ‘out of normal expenditure’ allowances, but if these are used elsewhere then the premiums will be potentially exempt or chargeable lifetime transfers depending on whether the trust is bare or discretionary.

Whether or not insuring the potential IHT charge on a pension will depend on the specific circumstances of the client. In addition to the factors detailed above, consideration also needs to be given to whether a gifting strategy is appropriate to move money out of pensions into trusts for tax reduction and bloodline protection reasons. These are, of course, not mutually exclusive and a degree of insurance may well still be needed alongside any gifting strategy.

All information is based on our understanding and interpretation of applicable law and regulation which is subject to change

 

 

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