Pensions, Protection and Inheritance Tax: A Client Case Study

The clients in this case are a married couple who I’ve worked with for many years. Now in their 70s, they’ve accrued significant wealth throughout their careers. They have three adult children, who they want to eventually inherit their estate. It quickly became clear that estate planning would be an important issue. A combination of mitigating Inheritance Tax (IHT) and making sure they retained enough wealth to meet their own needs became key objectives.

Our calculations show that, once their combined pensions come into their estate post April 2027, their total IHT liability could sit at around £2 million. Having already made significant gifts to their children, the most viable option for them to mitigate this significant IHT bill would be Whole of Life Insurance (WOL) on a Joint Life basis paying out on second death. As expected, the premiums are expensive, but we’ve shifted the perspective in our planning and have begun thinking of WOL as a guaranteed savings plan, rather than a protection product with costly premiums.

Although the premiums would be high, we can rationalise the cost by comparing them with the predicted IHT bill. Our planning shows that the couple would need to live for another c.40 years before the total premiums become more costly than the sum assured. With both clients in their mid-70s, this gives them as much confidence as possible that they are unlikely to find themselves in that position.

We’ve now started the process of applying for life cover. The next factor to consider is how they will fund the premiums, as they do not currently have the income stream to meet this comfortably. As it stands, we’re looking at options for funding the premiums in the most tax-efficient way.

Going forward, pensions are likely to become one of the least inheritable assets clients own. Currently, most unspent pensions fall outside a person’s estate for IHT purposes, which is why it has been common for retirees to spend ISAs and savings first, preserving pensions for as long as possible. However, for deaths on or after 6 April 2027, most uncrystallised pension funds and pension death benefits will be brought within the value of a deceased person’s estate and subject to IHT, meaning this strategy is no longer such a practical way of passing on wealth to the next generation.

The position becomes even less favourable for those who die after age 75. On top of the new IHT exposure, any pension funds drawn by beneficiaries will also be subject to income tax at their marginal rate, potentially leaving the fund facing both charges.

With the pension fund becoming one of the least inheritable assets, one option we’re exploring with the clients is using part of their drawdown pensions to buy an annuity to cover the premiums for the Whole of Life plan. The ensures the payments are guaranteed for life, meaning clients do not have to worry about investment risk when meeting the Whole of Life premiums.

It is important for the WOL plan to be placed into Trust. This will ensure that, on the second death in the marriage, the life insurance will be paid out promptly ahead of probate and outside of the estate, going directly to the beneficiaries. With the money going directly to the beneficiaries they will then have the funds available to pay the inheritance tax bill without the need to sell assets.

By completing this planning, we are not only helping to protect and maximise the clients’ wealth in the most efficient way, we are giving them peace of mind and confidence that they can pass on as much of their estate as possible to their children, without it being unnecessarily diluted or reduced by IHT.

This is an example only and should not be taken as personal financial advice. Everyone’s circumstances are different, and what may be right for one person may not be right for another. It is important to seek professional financial advice before considering your options.

Colmore Partners is an Appointed Representative of Best Practice IFA Group Limited which is authorised and regulated by the Financial Conduct Authority, the registration number is 223112.

This article is provided for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial product. For guidance, seek professional advice.

This article does not constitute tax, legal or financial advice and should not be relied upon as such. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. For guidance, seek professional advice.

Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested. A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.

Note that life insurance and financial protection plans typically have no cash in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse.

Cover is subject to terms and conditions and may have exclusions. Definitions of illnesses vary from product provider and will be explained within the policy documentation.

Annuities are long-term, complex financial instruments that may not be suitable for all investors. All investments carry risk, and annuities are no exception. The performance of an annuity is not guaranteed and can be affected by market conditions and other factors. It is essential to carefully consider your financial situation, investment objectives, and the product’s fees and restrictions before purchasing an annuity. Always seek professional financial advice.’

The Financial Conduct Authority does not regulate estate planning or tax planning.