How Your Pension Can Help with Inheritance Tax

Throughout your working life, you will most likely be paying into a pension scheme. While they can allow you to save effectively for later life and your retirement, these schemes are also useful for helping you to reduce the amount of Inheritance tax your loved ones will have to pay.

Due to their special status under tax rules, pensions can be passed on without becoming part of your total assets, known as your estate. As Inheritance Tax is only applicable on estates over £325,000, pensions are a useful method of passing on your money. We’ve put together a guide to advise you on top tips for using your pension to leave your loved ones money.

You can’t do it with all pension schemes

This method does not work with all pension schemes, only with defined contribution pensions. These are private pensions that build up your money using contributions from both you and your employers. This money is then invested in various places, either of your choice or a predetermined investment, to gain returns on your money.

If you take your pension as a tax-free lump sum when you retire and don’t use it all before you die, this money will be added to your estate. By leaving it in your pension, you are creating a fund that could reduce or eliminate the tax on the sum.

If you want to pass money onto your loved ones using this scheme, it is advisable that you leave your pension pot alone during your retirement if you can and instead spend any other savings first. This will keep your money inside the potentially tax-free pension scheme, while also reducing the size of your estate.

The age cut-off

It is also worth noting that 75 is a key age for this method. Should you die before you turn 75, any pensions can be passed on tax-free. From here, your loved ones have 2 years to withdraw the money from the scheme without facing any Inheritance Tax. Unlike your own pension, they do not have to be over 55 to withdraw from the scheme. If you are over 75, some taxes will occur for your loved ones. However, this is most likely to be lower than any Inheritance Tax they’d face outside the pensions scheme. They will instead pay their own rate of income tax on the money they take as their inheritance. Money can be withdrawn in regular sums or bigger one-off instalments.

Monitor your money

While pensions are a fantastic way to pass on your money, make sure you are aware of what your pension is doing. It is important that you are always checking where your money is invested. Your money could be placed in a ‘default’ fund. The idea of these funds is that they automatically choose and enrol you in a scheme when you first sign up, meaning you have no control. Alternatively, if you are responsible for choosing where your money is invested, make sure you revisit your investments every few years to ensure that it is still a worthwhile cause. If your money is poorly invested, you will not see a great return, or could even lose money if markets shift dramatically. Asking a financial adviser about your investment portfolio can help to secure a diverse and successful selection of investments.

When you are putting your money into a pension scheme, you must consider whether you are willing to take risks. If you are not planning on touching your pension for a long time, you can afford to take some risk. Taking risks in your pension is best done when you are young, as this will give you time for recovery should any investment fail. However, as these high-risk opportunities are more likely to produce good returns than any low-risk schemes, it is always worth considering.

Before you invest any of your money or set up a pension, it is always best to consult with a financial adviser first so you can make an informed decision.

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