Pensions – a simple guide

Posted on By admin
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Pensions are far more than a way to save for your retirement. This article aims to explain the basics of pensions and what you need to consider about your own pensions.  

Types of pensions

Apart from the State Pension, there are two main types:

  1. Defined contribution (DC) schemes, which are also known as ‘money purchase’ schemes. These include personal pension plans, self-invested personal pensions (SIPPs) and workplace pensions.
  2. Defined benefit (DB) schemes, which are also known as ‘final salary’ schemes. These include NHS, teacher and government pension schemes.

A bit about tax

Pensions are a very tax efficient way to save. As long as you remain within the maximum limit, you receive tax relief on contributions paid into your pension.

Also, investment growth and income in your pension fund is tax free. When you take money out of your pension, you can take part of the fund as a lump sum, tax free.

How much can you pay into a pension?

You can make contributions that qualify for tax relief by whichever is the lowest amount of either:

  • 100% of your ‘UK Relevant Earnings’ (Tool Tip: For most people, this includes salary and bonuses. They exclude dividends, rent and some other payments, such as withdrawals from investment bonds) or the
  • Annual allowance, which is currently £60,000 (2023/24).

If you earn more than the annual allowance, you may still be able contribute more by using unused allowances from previous years. Also, someone under 75 with no earnings can contribute £2,880 (net) or £3,600 (gross) which includes children! If a child contributes to a pension, their parent or legal guardian looks after it until they are 18.

What happens when you die?

In most cases, if you die leaving a ‘residual’ pension fund, your nominated beneficiaries receive it, inheritance tax (IHT) free. The residual fund is the amount left in the fund when the person dies.

However, it is important that you set up either a ‘nomination’ or an ‘expression of wishes’ to explain who you want to receive your pension. This can be a family member, charity, friend or a trust. You can change your nomination at any stage. It is a good idea to review it periodically.

The death benefits on most pensions are held under a discretionary trust. Find out more about what a discretionary trust is.

The people who run the trust will usually only deviate from your stated wishes if significant circumstances come to light. For example, they might do so if you had got divorced and remarried many years after setting up your nomination, but not updated it.

If you die before you turn 75, the people you choose to receive your remaining pension fund will get it without having to pay any income tax. However, if you die after reaching 75, the recipients will have to pay income tax based on their own tax rates. This applies whether they take the money as a lump sum or regular payments.

You also have the option to nominate a ‘bypass’ trust to receive your pension fund when you die. However, if you choose this option and die after 75, a 45% tax charge will be applied to the amount paid out from your pension fund. This tax charge will be deducted directly by your pension scheme administrator and paid to HMRC.

This is why it’s advisable to review your nomination as you approach 75 to avoid this tax charge. However, it’s important to note that there might be valid reasons for not changing your nomination.

The role of pensions in planning your estate

Because a pension fund is held outside of your estate, the value does not typically suffer IHT when you die, which opens up a number of opportunities to plan your estate in a tax efficient manner.

Robin Melley TEP, Founder and Director, Matrix Capital, Chartered Financial Planners

I want to give money to my family, friend or a charity. What do I need to know?

Posted on By Liz Skinner
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Many people decide they would like to make gifts, usually to a family member, friend or charity, at some point in their lives. Such gifts can be money or objects with financial or personal value.

Their motivations can vary, from wanting to support a family member getting started in life or to help someone close to them overcome difficult circumstances. Others may wish to support a charity or mitigate their own income tax, capital gains tax or inheritance tax liability.

Whatever the intention, it is a good idea to have a basic understanding of the different types of gifts and the possible consequences of gifting.

Unintended consequences

It is important to understand the tax consequences of gifts and the impact upon areas such as your retirement or later life provision. This helps avoid unintended consequences, and ensure that gifting does not jeopardise the long-term financial position of the person making the gift.

For example, making a large gift to a family member might help the recipient and reduce the donor’s inheritance tax liability. It may also mean they risk running out of money in later life if they need expensive nursing care. It is therefore vital that gifting is considered as part of a holistic financial plan and the overall impact is understood before finally making the decision.

The basics

A gift to an individual of any amount that is not otherwise exempt is a called a Potentially Exempt Transfer (PET) and will not trigger an immediate inheritance tax charge.

If you survive seven years from the date of the PET, it will not be subject to inheritance tax. If you decide to make a gift of more than your available Nil Rate Band (currently £325,000) your estate may be able to claim Taper Relief if you were to die after three years from the date of gifting. Taper relief only applies if the total value of gifts made in the seven years before you die is more than the available nil rate band.

A gift made during your lifetime to a discretionary trust is subject to inheritance tax when the gift is made. Your gift is taxed at 0% up to your available nil rate band, and then taxed at 20% on anything above that.

Should you die within seven years of the date of the gift, its value is added back to your estate and potentially taxed at 40%, less any inheritance tax previously paid at the time the gift was made, considering any nil rate band available at the time of death.

Gifting can also be useful in capturing the residential nil rate band (RNRB), which is an additional nil rate band that is associated to the main residence where it is ‘closely inherited’ upon death.

For example, a lifetime gift may reduce the value of your estate to below £2m, which may allow your personal representatives to claim the full RNRB, which currently stands at £175,000 per person. So, for a couple, who are married or in a civil partnership, this approach may reduce the overall inheritance tax liability by up to £140,000 (£175,000 x 2 x 40%).

It is very important to consider the timing of gifts and the order in which you make them, particularly where you intend to establish a discretionary trust. Carefully planning gifting with the support of a STEP Trust and Estate Practitioner should avoid any difficulties.

Read more about gifts in the second part of this briefing

Robin Melley TEP, Founder and Director, Matrix Capital, Chartered Financial Planners

How can I gift money without worrying about inheritance tax? And how do gifts affect my Lasting Power of Attorney?

Posted on By admin
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The following gifts may be made without worrying about inheritance tax:

The Annual Exemption, which is currently £3,000 per tax year, per individual donor (not the person receiving the gift, or ‘donee’). If last year’s has not been fully used, any remaining exemption may also be used. For example, a couple that has not used either last or this year’s exemptions, could gift up to £12,000 in total by using four annual exemptions this year.

Small gift – £250 per donee, but they cannot be used in conjunction with the annual exemption and there is no limit to the number of individual donees who can benefit.

Gifts in consideration of marriage/civil partnership – each tax year, the maximums are £5,000 if gifting to a child, £2,500 to a grandchild or great-grandchild and £1,000 to anyone else.

To claim this exemption, the gift must be made on or before the date of marriage or civil partnership and not afterwards. It can be combined with the annual exemption. If the marriage does not take place, the relief is denied and, if not covered by another exemption, the gift is a Potentially Exempt Transfer (PET) and potentially taxable when the donor dies.

Gifts of any amount to a spouse or civil partner.

This is called the ‘spousal exemption’ and any amount may be transferred either during their lifetime or upon death.

Charities – full exemption on lifetime gifts and upon death. Also, the inheritance tax rate reduces to 36% where at least 10% of the net estate is left to a registered charity upon death

Gift Aid – donating through Gift Aid means charities and community amateur sports clubs can claim an extra 25p for every £1 given.

The tax could have been paid on income or capital gains. The charities being supported must be told if you stop paying enough tax. If you pay tax above the basic rate, the difference between the rate you pay, and basic rate may be claimed on your donation. 

Wills and lasting powers of attorney (LPAs)

It is a good idea to consider what your will says before gifting to make sure that the proposed gift does not disturb your intentions upon death.

Having a properly drafted LPA for property and financial affairs, with appropriate preferences and instructions, may allow your attorneys to continue to make payments on your behalf in circumstances where you have lost mental capacity, without first having to obtain an order from the Court of Protection.

Top three tips

  • Take professional advice from a financial planner who is also a registered STEP qualified trust and estate practitioner.
  • Properly consider what you are attempting to achieve because there may be a better way that does not involve gifting.
  • Take a holistic approach and base your decisions on a well thought out and robust financial plan before implementing gifts, particularly where significant amounts are involved.

Robin Melley TEP, Founder and Director, Matrix Capital, Chartered Financial Planners