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Legal
Baby Boomers are spending to avoid Inheritance Tax
In recent years, there has been a noticeable trend among the baby boomer generation choosing to withdraw large sums from their pensions.
The primary motivation behind this decision is to avoid the hefty inheritance tax that would otherwise be levied on their estates. This blog post will explore the reasons behind this trend, the implications for retirees, and expert commentary from a probate and estate planning lawyer.
Understanding Inheritance Tax
Inheritance tax is a tax on the estate (property, money, and possessions) of someone who has died. In the UK, the standard rate is 40%, which is applied to the value of the estate above a certain threshold. For many, this tax can significantly reduce the amount of wealth passed on to their heirs.
The Pension Lump Sum Strategy
To mitigate the impact of inheritance tax, many older people are opting to withdraw lump sums from their pensions. By doing so, they can spend or gift this money while they are still alive, thereby reducing the value of their estate and the subsequent tax burden. This strategy is particularly appealing because pension withdrawals are often taxed at a lower rate than inheritance tax.
Why This Trend Is Growing
Several factors contribute to the growing popularity of this strategy:
1. Awareness
Increased awareness of inheritance tax and its implications has led more people to seek ways to minimize its impact.
2. Financial Flexibility
Withdrawing pension lump sums provides retirees with immediate access to funds, offering greater financial flexibility.
3. Gifting
Many older individuals prefer to see their loved ones benefit from their wealth while they are still alive, rather than leaving it to be taxed heavily after their death.
4. Removal of inheritance exemption from pension
Currently most pensions are not deemed to form part of an estate for inheritance tax purposes, which means family and loved ones can inherit a pension tax free. However, this is changing from April 2027, when unspent pension funds will be considered when calculating an estate’s IHT liability.
Potential Risks and Considerations
While this strategy can be effective, it is not without risks. Retirees must consider the following:
- Longevity: Withdrawing large sums can deplete pension funds, potentially leaving individuals without sufficient resources for their later years.
- Tax Implications: Depending on the amount withdrawn, pension lump sums can be subject to income tax, which may offset some of the benefits.
- Financial Planning: It is crucial to have a comprehensive financial plan to ensure that the strategy aligns with long-term goals and needs.
Manzurul Islam, Head of the Wills & Probate team, said:
“The changes to the inheritance tax regime highlights the importance of pro-active estate planning. It is likely to lead to more people accessing their pensions earlier to avoid larger IHT bills on death. Seeing your children and loved ones enjoying the wealth earlier also has its obvious attractions.
Gifting money while alive can be a smart move, but it should be done strategically to take advantage of available allowances and exemptions. Estate planning should be holistic, taking into account all assets and potential tax implications (for example Capital Gains, Income Tax etc.), so it is best to consult with an expert.”