Can I gift my pension to my grandson now to avoid paying inheritance tax? ...Middle East

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Question: Because the favourable inheritance tax (IHT) regime is now ending, I am considering whether to reduce the amount in my pension and look at alternatives. My understanding is that I can take 25 per cent tax-free from my pension at any point and then the remaining pot is taxed on withdrawal at marginal rates.  We do not need the cash immediately as we have other resources to call on and our ISAs produce a regular income. But given the pending change in IHT treatment, I am considering taking the 25 per cent tax-free cash and gifting at least some of it in the hope of surviving seven years. Is this sensible?

Answer: Under current rules, unspent pensions can usually be inherited completely tax-free if someone dies before age 75, with an income tax charge at the beneficiary’s marginal rate applied if the death is after the person’s 75th birthday.

All this changes from April 2027, when these funds will be valued as part of your estate for IHT purposes. Where the total value of your estate exceeds your available IHT “nil-rate band” – the value of assets you can pass on without an IHT tax charge applying – a 40 per cent tax charge will apply on the excess if not being passed to a spouse, civil partner or charity.

Most people will have a main nil-rate band of £325,000 and a main residence nil-rate band of £125,000.

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While IHT affects a minority of households, the combination of frozen thresholds and unspent pensions being brought into the IHT mix means the number of households affected will rise in the coming years.

If you are in this position and are planning to pass your assets onto someone who isn’t your spouse or civil partner (these transfers of assets remain outside the scope of IHT), then gifting is an option you might want to consider. Before going down the gifting route, make sure you are confident you have a big enough pension to fund your retirement.There are a number of options you could consider.

Tax rules allow you to gift up to £3,000 each tax year, exempt from IHT. You can also give small gifts of up to £250 each (although these small gifts cannot be given to people who receive all or part of the £3,000 gift).

Alternatively, you can make a gift of unlimited value to someone, which will escape IHT if the giver of the gift survives for another seven years (the “seven-year” rule).

If the giver dies in this period, then usually the full value of the gift will be included in their estate when working out inheritance tax, but taper relief will be available if the giver survived giving the gift by at least three years.

It is also possible to make regular gifts to another person out of your income. To meet the rules to be exempt from IHT, the gift has to be part of the giver’s normal expenditure; it has to be made out of income; and it has to leave the giver with enough income to maintain their normal standard of living.

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This can be a useful exemption from IHT, but it’s also complicated, so care needs to be taken and appropriate paperwork kept. If you are considering this, it’s probably best to get expert help and advice.

Gifts can also be made to trusts, but there are complicated rules around setting up trusts, as well as additional costs, so again, you should seek regulated advice before going down this road.

One final thing. As well as making outright gifts to family members, some people may want to pay the money into someone else’s pension or ISA. If you pay into a pension like a Self-Invested Personal Pension, then the pension holder may receive tax relief on the contribution, boosting the overall value of their retirement pot and their income in later life.

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