David Kaye talks to FT Adviser about whether pensions are more viable solution now to estate planning challenges The scrapping of the lifetime pension allowance (LTA) on 6th April 2023 was an unexpected move from the UK government that was broadly well-received amongst the pensions and investments industry. Individuals now have the ability to save into their pensions without the concern of additional tax charges should the limit be breached. However, with IHT receipts continuing to rise, do pensions now provide the wholesale solution for the estate planning challenges that individuals currently face?
A recent survey1 from M&G Wealth found that financial advisers and paraplanners believe more clients will use pension pots to pass wealth on to dependents after the abolition of the LTA. Close to 90% of advisers who responded either agreed or strongly agreed that the abolition of the LTA will mean more people would be using their pension to pass wealth to the next generation.
The scrapping of the lifetime pension allowance therefore is widely seen as a positive move, since people are now able to put more into their pensions which will not be liable for IHT when they die. However, removal of the LTA is not a panacea for inter-generational financial planning. Importantly, whilst the lifetime contribution limit has been scrapped, limits remain on the amount that can be contributed into a pension each year with higher earners subject to a cap of £60,000 per annum. This materially reduces the ability to use a pension to mitigate IHT for those with substantial assets.
Pensions can also be restrictive should an individual need to access their capital. Normally, pensions cannot be accessed until the aged of 55. There are also limits on how much can be withdrawn without being taxed: only 25% of a pension can be taken out before withdrawals start to get taxed as income. These factors need to be carefully considered with clients as IHT is only one part of the picture and if circumstances change, withdrawing capital can be expensive.
There are options for clients seeking IHT mitigation that address the limitations of pensions both in terms of annual contribution caps and ability to access capital, which are worthy of consideration alongside pensions, namely Business Relief qualifying investments. These investments if held for two years and at the point of death are deemed to be outside the estate for IHT purposes – both the initial capital and any growth in value of such investments.
To qualify for Business Relief, investments must meet certain requirements: the rules are complicated but in essence, investments in trading companies (as distinct from companies making or holding investments) may qualify for Business Relief. Whilst this does not extend to listed companies, the Government included trading companies admitted to the Alternative Investment Market (AIM) as able to qualify for Business Relief. Importantly, this is not all AIM companies, but only those engaged in a trade. Indeed, as AIM stocks may be held in ISAs it is possible to combine the tax-efficient characteristics of ISAs during an investors’ lifetime with IHT mitigation on death by investing in a portfolio of AIM stocks.
So why are Business Relief qualifying investments attractive?
Firstly, unlike pensions, investors retain access to their capital without the limitations described above. Secondly, there is no mandated cap on the amount that can be invested in Business Relief qualifying investments in any single year.
As a means of mitigation IHT, Business Relief qualifying investments also compare favourably to gifting, that is giving away money during an individual’s lifetime. Whilst gifting is an option to reduce IHT, with the ongoing cost-of-living crisis, this is becoming increasingly less popular. Moreover, as clients are gifting the capital, they no longer have control of it should their circumstances change. In addition, it can take 7 years for the value of the gift to be outside a client’s estate. Business Relief qualifying investments allow clients to keep shares in their name and keep hold of their wealth should they need it. In addition, in contrast to gifting, after only 2 years, the value of the investment can be IHT-free.
In terms of how to make Business Relief qualifying investments, clients can of course invest in companies directly, both private and those trading on AIM. However, as noted above, the rules are complex and it is therefore worthwhile considering the wide array of discretionary portfolio services available which can provide access to Business Relief qualifying investments. Several fund managers have developed good track records of performance, offer diversification and often carry out annual audits with independent advisers to check that their portfolios meet the Business Relief rules.Although sentiment towards scrapping the LTA is largely positive, it is important to consider a holistic approach when sitting down with clients to consider inter-generational planning. Having the option of an unlimited pension is one way to limit IHT for beneficiaries but there are material drawbacks in terms of amounts that can be contributed and accessing capital which can be addressed with other options, including Business Relief qualifying investments.