There are a few issues to unpack when dealing with this question. Firstly the government has announced that with effect from 6 April 2027 pensions will be included in your estate for Inheritance Tax when you die. If you are married or in a civil partnership then your pension will pass tax free to your spouse or Civil partner but when they die the value of the estate is totted up and Inheritance tax will apply after any available reliefs are deducted.
Prior to the October budget Pensions were exempt from Inheritance Tax and were a handy vehicle for passing on your wealth to your beneficiaries. That has now been closed off, so what should you do with your pension before you die?
The simplest answer is to spend it, but if this isn’t an option then financial advisers in Leeds have been scratching their heads and coming up with possible ways of avoiding the Inheritance tax which may result.
One possible method is to purchase an annuity with part of your pension fund: this will provide a regular income stream for a defined period ( – known as a short or fixed term annuity) or for the rest of your life and your spouse or civil partner’s life (- sometimes called a Life Annuity). If you do that then you are deemed to have spent the capital you used to purchase the annuity and it reduces the value of your estate for Inheritance tax.
Fixed term annuities offer a regular income for a set period, and at the end of the period you have options and can choose to take another fixed term annuity, take the funds as a lump sum or move it into drawdown. The higher the income you receive from the annuity, the lower the maturity amount. You can guarantee the maturity amount so if you die during the fixed term some or all of the capital comes back into your estate.
Fixed term annuities are sometimes used to bridge the gap between retirement and State Pension Age where the annuitant wants to ensure that he or she has a basic income for the full term without being exposed to the investment risks of an invested pension.
If you die during the fixed term annuity and do not have a guarantee then the original capital is gone and no Inheritance tax will be due. But if you have guaranteed some or all of the original capital then when you die it will come back into your estate and be counted when calculating how much Inheritance tax is due. Furthermore the income stream itself may still be subject to Inheritance tax if it’s passed to beneficiaries who are not your spouse or civil partner.
So a short term annuity will not fully avoid your Inheritance tax problem, but it can help reduce the amount potentially owed.
We are happy to have a conversation with you around your Inheritance tax worries and our first appointment is free of charge. We are fully independent Financial Advisers Leeds based in Roundhay LS8 2LQ. Please ring 0113 322 0700 to set up a complementary initial meeting. Our website is www.lazenbysfs.co.uk
I look forward to meeting you.
Russell Blackhurst Llb Dip Pfs, Financial Advisor Leeds.
