Private Pensions and IHT

Please be advised that the information in this article regarding QNUPS and IHT is no longer accurate due to the recent changes announced in the UK Budget. Starting in April 2025, the regulations will have significant implications that may affect your understanding of these topics. We encourage you to stay informed and consult with a Soteria Trusts expert to navigate these changes effectively.

Frozen IHT tax thresholds and soaring property prices put more and more families at risk of hefty IHT bills. In fact, in the tax year 2021/2022 HMRC collected £6.1 billion in death duties, which equals £700 million or 13% more IHT than in the previous year. This makes it even more important that you organise your retirement savings and investments in the most tax-efficient way!

But aren’t pensions IHT-free? 

In theory, private pensions are one of the most tax-efficient ways to save for retirement, as in principle, they are exempted from IHT. But as it turns out, there are circumstances when your pension fund won’t be passed on to your beneficiaries free of Tax. Private pensions are usually defined as contribution pensions. And any cash left in a defined contribution pension fund can be passed on to your heirs IHT-free. However, they’ll pay income tax on the money only if you were 75 or over at the time of your death. 

Related: Are all Pensions IHT-free?

Pensions taxes 

As you can see, if you are in good health and planning to live and enjoy your retirement past the age of 75, you and your beneficiaries might be at a disadvantage. While the fund won’t be taxed for the death duties and included in the rest of your taxable estate, your loved ones may have to pay high taxes for receiving your hard-earned money. 

Moreover, your private pension withdrawals will be subject to normal income tax rates, with only £12,500 for the 2020/21 tax year as an annual allowance. 

The Lifetime Allowance (LTA)

If you enjoy a successful career and want to live a truly comfortable life in retirement, then it makes sense that in order for you to enjoy more later in life, you will need to save more each year than Mr. Joe’s Average. Whilst the concept that the more you save, the more you will reap in later life is true, it can also backfire on you, too; that’s because there are limits to how much you can contribute to your pension over your lifetime. The Lifetime Allowance is £1,073,100 in the tax year 2021/22, with an annual allowance of £40,000. The allowances apply across all of the pensions you have – that’s both private and employer-sponsored arrangements. 

You will need to pay tax if the total value of your pension benefits exceeds this LTA. Any excess taken as a lump sum is taxed at 55%. Regular withdrawals may be subject to income tax charges of 25%. Even though the pension fund will sit outside your estate and not be subjected to IHT, your retirement income will be taxable at the prevailing personal income tax rates of 20, 40, or 45%, with any excess withdrawals taxed at an additional rate of 55%.

IHT and the rest of your estate

Pensions are probably not the only assets you have or want to have for your retirement and for your family or other beneficiaries to inherit. You may have other investments, stocks, property, and collectables that have value and are indeed part of your taxable estate. 

Related: What is included in your estate for IHT?

A popular route for some people is to use their other savings accounts as their retirement income before drawing down from their pension funds. This way, they’ll reduce the size of their taxable estate and, by doing so, minimize the IHT bill. But this approach only helps to minimise tax on those non-pension accounts you manage to use up while any other accounts remain exposed to IHT. So, too, are any unused private pension funds, which will be taxed heavily if you die after the age of 75.

There is a way to save for retirement and have the fund IHT-free, Income-Free, and Capital Gains-Free. 

The aforementioned solution is affectionately known as a QNUPS, which stands for Qualifying Non-UK Pension Scheme (QNUPS). A QNUPS is a specific type of pension recognised by HMRC, established and operating from outside the UK, as the name suggests. 

Trust-based QNUPS

First introduced in 2006, the original QNUPS were typically Trust-based pensions. The legislation hasn’t changed since 2010, but certain tax rules have left those Trust-based schemes less attractive overall than they were, especially for landlords. That’s because when the internal assets of a Trust-based pension are investments or BTL properties, it is now taxed, unlike before. The Trust is taxed at a flat rate of 45% on non-savings and interest income and 38.1% on dividend income after the first £1,000 per annum. 

Related: Difference between Trust and Contract-based Pensions explained

Contract-based QNUPS

The more modern and tax-efficient QNUPS, which are widely used today, are those administered under ‘Contract’ rather than Trust. The contract schemes have some subtle but significant differences that make them more popular. The Contract scheme has a Custodian who holds the assets on behalf of the member in exactly the same way as a Trustee does, but he does so without having any discretionary powers, which sit more comfortably with those who don’t like the idea of giving their assets away. There is no 45% income tax levied on rental income received into Contract QNUPS making it significantly more attractive to landlords.

Summary: Benefits of QNUPS in IHT and Retirement Planning

Both QNUP types are not subject to the Lifetime Allowance limits, making them a very tax-efficient way to fund your retirement while ensuring the pension fund is free from any IHT from day one. That means no or low-Income Tax for you in retirement (subject to the residence and DTA’s), no Capital Gains Tax should you decide to dispose of any of the assets held, and no IHT liability for your beneficiaries once you pass away.

QNUPS are really an all-around tax-efficient vehicle, but they aren’t for everyone. To find out whether you and your circumstances are right to use a QNUPS, contact the team at Soteria for a complimentary assessment. We promise that, if nothing else, you will be better informed about QNUPS and other IHT strategies following a review. 

We also invite you to our monthly seminar, which discusses using trusts and contract pension structures in UK tax planning.