As a nation we are living longer. According to the Office for National Statistics (ONS) in 2010 there were 4.9 million people aged over 75, fast forward 10 years and this has grown by a huge 24%, to 6.1 million in 2020. The need, therefore, for some form of care in later life is a real fear among most families which is only growing. This fear comes from not only losing your independence but also losing the legacy you may have planned to pass to your loved ones. 

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A scary fact to add to this concern is the total beds available in care homes as a proportion of the population is decreasing. In 2012 there were 11.3 beds in care homes available per 100 people for those over age 75. Over a 10-year period this has reduced to 9.4 beds per 100 over age 75, this is a 17% decrease.  

In a time where emotions are high as well as stress being overwhelming, the last thing you need to worry about is whether your finances are working in the best way for you so you can afford the care you want or need. Taking the time to appropriately plan for potential care costs in good time will remove this financial worry, allowing you to focus on the health and wellbeing of you and your family.  

In terms of planning for care costs, a good place to start is to understand what these costs may look like. 

Costs of care today 

There is a common misconception that the state will pay for your long-term care. However, in reality only a few people will meet the eligibility criteria which prevents them paying the costs of care themselves.  

In 2023 the average cost for residential care in the UK was is £1,078 per week (£56,056 per year), according to the AgeUK Charity. However, figures will vary significantly depending on your location and the individual circumstances surrounding your care requirements. The first step in your plan would be to research care homes around you and what the typical costs for these are. In most cases, the preferred care home isn’t based on cost but on the distance from family members, so costs can sometimes be unexpectedly high. 

For the current tax year 2023/24, in England, you currently need to be below the savings threshold of £23,250 in savings and/or assets before part of the cost of care will be covered by the state and below £14,250 before all costs are paid (£28,500 in Scotland, £50,000 in Wales and £23,250 in Northern Ireland). This limit includes the value of your home unless you have a spouse or dependent occupying the property. This limit has not been increased to take into account the effects of inflation over the years, therefore fewer individuals are able to benefit from state support each year. 

If your assets are above these limits, then you will need to fund your care costs personally, which may even include your home. 

What is the social care cap? 

It is not all bad news, in 2021 the UK government proposed a price cap on care costs of £86,000, known as the ‘social care cap’, meaning this will be the maximum an individual would pay towards their care costs in their lifetime. The cap was originally due to come into effect as of October 1st, 2023, but has been postponed to October 2025 following Jeremy Hunt’s Autumn statement of 2023. Of course, with the prospect of a changing government on the horizon it’s easy to see that a lot could happen before the postpone social care gap would be implemented. 

Although there is the care cap this only covers the care costs, if you were to be in a residential care home you would still be liable to pay additional costs such as ‘hotel’ costs and luxury costs. 

Building your plan 

If you’ve identified that you will need to pay for care or you’d like to plan for the possibility and you’ve researched to understand what the costs look like in your area, you’re half way there in terms of building your plan. The next step is ensuring your current savings, investments and pensions are working hard and tax efficiently for you to ensure you have the best chances to meet this expense. 

If you are retiring and planning for care costs is important to you, a common mistake most individuals make is holding too much wealth as cash in your bank account. Although cash is very safe and won’t, in theory, go down in value, interest rates on bank accounts have historically been lower than inflation. Therefore, your wealth could be deteriorating in real terms. It is important to have a conversation with a financial adviser to build an initial plan and check if the overall assets you are holding are appropriate. 

If you are much closer to needing care, it is still important to plan the potential expenses out. This will help you to understand how long you would be able to sustain care costs until your wealth is below the threshold for the council to start making contributions. For a short-term solution, your plan may focus around cash accounts, which although may not provide the best return year on year, will provide certainty and peace of mind in the short term. 

If you are in a position where the majority of your wealth is locked away in your home, and you are single and living alone, this will keep you above the threshold. In this situation you will likely need to use this wealth in some way to cover the costs. You will have a few options open to you, which include: 

• Renting the house out.  

• Taking out a mortgage or equity release. 

• Have the council take the costs from the house (typically on death).  

• Selling your home outright. 

Each of these options presents potential benefits and drawbacks. For example, selling your home may provide you with a lump sum of cash that you can put towards care costs. However, you may lose your Residence Nil Rate Band (RNRB) on your property, which is an increase to the threshold for inheritance tax. Therefore, it’s important to assess each in turn and discuss with a financial professional.  

At The Private Office we look at your overall financial picture and discuss what is important to you. Our first step is to always build your bespoke financial plan, which will include potential care costs, and how you may be able to pay for these.  

To understand the features and risks of equity release, please ask for a personalised illustration.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

The Financial Conduct Authority (FCA) does not regulate cash flow planning, estate planning or tax advice.

Most parents would like to ensure their children have a strong financial footing when they are older, but don’t always know the best way to do this. There are many ways to support your children financially throughout their lifetime, but what if there was a way to make them a millionaire before they even reached retirement age? Here we look at the best ways to put money aside for your children and how you can maximise the benefits of compound interest to make your child a “millionaire”!

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The first step to saving for your children’s future is understanding your saving options. Here are the most common options that benefit from tax-free growth: 

Junior ISA(JISA)

From the day a child is born you can put money into a JISA for them. The current contribution limit is £9,000 per tax year (or £750 per month) and you have the choice of a Junior Investment ISA or a Junior Cash ISA. The most important benefit of a JISA is that any gains made, or interest earned will be tax-free!

If we assume you receive an average annual net return of 5% per year and you save the maximum of £9,000 every tax year, from the day your child is born until they turn 18, you will have contributed a total of £162,000 to their account. However, due to the magic of compound interest (where you earn interest on interest), they will have a pot of over £265,000 saved in a tax-efficient wrapper, what a great 18th birthday present!

At their 18th birthday they can transfer their JISA into an Adult ISA to continue to receive tax-free interest/ investment returns.

Junior Self-Invested Personal Pension (Junior SIPP)

Setting up a pension up for your children may seem like you are overly preparing but this can actually give your children a significant head start. The maximum you can currently save into a Junior SIPP is £2,880 per tax year, and the UK government will add tax 20% tax relief of £720 per tax year, which would bring the total contribution to £3,600. If you can contribute to your child’s Junior SIPP for 18 years and again assuming a 5% growth rate, you will have contributed £51,840 but their pension pot will be worth £106,340 due to the added tax relief. If your child doesn’t contribute to the pension again, by age 57* they could have a pension pot worth around £712,986. Similar to the JISA, any gains made within the SIPP are exempt from tax, and based on current pension rules, you can take up to 25% as a tax-free lump sum upon reaching retirement age. 

Recent statistics released by the Office for National Statistics (ONS) stated how the average pension wealth for all persons in the UK is £67,800 at age 57*, highlighting how starting to save early can set your child up for their future and give them a greater opportunity in retirement or even to retire early. 

How to make your child a millionaire!

And this is how to do it! If you do the following and assume a 5% growth rate per annum:

1. Open a JISA before your child’s first birthday and contribute £9,000 every year until age 18. This results in a total contribution of £162,000 (18 years x £9,000).
2. Open a Junior SIPP before your child’s first birthday and contribute £3,600 (including tax relief) to the Junior SIPP every year up to their 18th birthday. This totals 18 years x £2,880 (or £3,600 with tax relief) which equals £51,840 (£64,800)

This would mean you will have contributed a total of £226,800 (including tax relief) to the JISA (£162,000), and Junior SIPP (£64,800). At age 18 when you stop contributing, they could have a total net worth of £372,191 when taking into account compound interest and growth. If they leave this money invested and continue to achieve 5% per year growth, by age 39 they could have a total net worth of just over £1million (£1,036,911), although the funds in the pension would not be accessible until age 57*. 

At that point the pension fund could have grown to £712,986, while the ISA, could be worth £1,782,465 if it remained untouched too - an extraordinary total of almost £2.5m. That is a gift worth giving.

The power of starting to save early

Using the same assumptions as above, with a 5% annual growth rate and maximising both Junior SIPP and JISA contributions until age 18:

This shows the benefits you can provide by starting the process of saving early for your child through compounding the interest or investment returns. This is a representation of how you can save for your children and assumes maximum contributions are made at each birthday, but we understand the circumstances for each parent and child will be different and may require different forms of financial planning, such as monthly contributions instead of lump sums.

Despite the examples above, it is never too late to start. If you would like to understand how, The Private Office can structure savings and investments for you and your children to help provide the whole family with a strong financial future. So why not get in touch for a free initial consultation. 

* Based on current pension regulation, where the normal minimum pension age is increasing to age 57 from April 2028. 

If you would like to know more about this topic, one of our Partners Kirsty Stone appeared on BBC Radio 4 Money Box live, giving her suggestions in a programme all about saving for children.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

All the calculations in this article assume that lump sum contributions are made for 18 years, from birth, unless otherwise stated, to the 17th birthday and are not adjusted for inflation.

The Financial Conduct Authority (FCA) does not regulate tax or cash advice.

The growth rates provided are for illustrative purposes only.  Investment returns can fall as well as rise and are not guaranteed.  You may get back less than you originally invested.  Investments may be subject to advice fees and product charges which will impact the overall level of return you achieve.

Chancellor Jeremy Hunt promised to ‘reduce debt, cut taxes and reward work’ in his ‘Autumn Statement for growth’, but what might the changes he announced mean for your personal finances?

In the lead up to the Autumn Statement, we discussed the changes that were rumoured to have been announced in this article.

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These speculated changes included:

• Reducing Inheritance tax
• Announcing an additional ISA allowance for investment into UK companies
• Changing the state pension triple lock calculation to limit next year’s state pension increase

In the end, none of these changes were introduced, with shadow chancellor Rachel Reeves claiming Hunt wanted to reduce inheritance tax but that he “couldn’t get away with it in the middle of a cost of living crisis”.  Instead, the headline grabbing change was the 2% reduction to employee national insurance contributions between £12,571 and £50,271.  This will equate to an annual saving of c. £754 p.a. to those earning over £50,270 p.a. with effect from January 2024.  Additionally, there were National Insurance reductions for the self-employed, with Class 2 contributions effectively abolished and Class 4 contributions reduced from 9% to 8% between £12,571 and £50,271 with effect from April 2024.

However, this will only go part of the way to make up for the impact of the continued freezing of the income tax bands, which will remain frozen until 2028.  Indeed, as a result of higher inflation, higher interest rates and frozen tax bands, the Office for Budget Responsibility (OBR) states “Living standards, as measured by real household disposable income per person, are forecast to be 3.5 per cent lower in 2024-25 than their pre-pandemic level.” 

Separately, the speculated ISA allowance increase for investments into UK companies did not materialise and pensioners will be pleased to hear Mr Hunt state the government will “honour our commitment in full” as the state pension rises by 8.5% next year.

Regarding pensions, workers will hope a new legal right for their new employer to pay into their previous defined contribution pension scheme will simplify pension planning going forward and will mean an end to the accumulation of multiple schemes as individuals move between companies.

This was an Autumn Statement with half an eye on an upcoming general election, with announcements that should put more money in the pockets of workers and pensioners alike. Mr Hunt repeatedly referred to the OBR’s forecasts during his announcement as he tried to rebuild credibility, a little over a year after Liz Truss and Kwasi Kwarteng’s ‘mini-budget’, prior to which the OBR was not asked to run forecasts. Overall, Mr Hunt will have been grateful that he was able to use some of the fiscal headroom provided by then Chancellor, now Prime Minister, Rishi Sunak’s decision to freeze income tax bands back in 2021 to offer a national insurance cut and significant state pension rise to the voting public. 

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The opinions shared in this article are solely those of the individual and they do not necessarily reflect those of The Private Office.  

There is no denying the charity sector is feeling the strain. Running costs, declining government support and demand for services are rising, while disposable incomes are being squeezed by increasing taxes, frozen allowances and an uncertain economic climate.

As a result, organisations are being forced to think differently about how they raise money in the current climate. Some are placing a greater emphasis on “legacy fundraising” i.e. when someone designates part of their estate to a chosen charity in their will. Nevertheless, this method of fundraising could face future challenges.  

Additionally, multiple news outlets are reporting that Prime Minister Keir Starmer is considering plans to increase inheritance tax revenue by tightening rules around the gifting of assets, among other suggestions, at the next budget. This could mean that charitable tax incentives would become less prominent as a way to mitigate tax for high-value estates, which could have an impact on the number of people who leave assets to charity in their will. While we await the outcome of the impending budget, for now, those looking to minimise their tax bill while doing good for the world have a golden opportunity.  

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How can I reduce Inheritance tax by giving to charity?

Currently, gifts to registered charities are exempt from inheritance tax (IHT). This can either be done through donating during your lifetime, or on death through your will.  

As a reminder, everyone has a ‘nil rate band’ exemption for IHT, (currently at £325,000 per person). Furthermore, if you are passing your main residence to your direct descendants, you can also benefit from an additional exemption of up to £175,000 – this is known as the “residence nil rate band”. 

Case Study 1 Example:

Mr A has an estate valued at £550,000 including a £300,000 main residence that he is planning to pass on to his children. He also utilises his annual gifting allowance every tax year. As a result, Mr A will benefit from £500,000 of allowances, as per below:

• £325,000 nil rate band
• £175,000 residence nil rate band

The excess (i.e. £50,000) would ordinarily be taxed at 40%, leading to a £20,000 tax liability. However, if Mr A left £50,000 to charity, his estate (now £500,000) would fall within the respective nil rate bands, which means there would be no inheritance tax to pay. 

Bequeath on death

Further to the above, you also have the potential to reduce the rate of inheritance tax to 36% if you leave at least 10% of your net estate to charity. This is typically achieved by leaving a charitable gift via your will.

The net estate  "baseline amount" is calculated by deducting IHT exemptions, reliefs and nil-rate band from the total estate value (however this does not include the deduction of the residence nil-rate band).  

If the value of the gift is at least 10% of the "baseline amount", the reduced 36% rate of inheritance tax will be applicable.

Case Study 2 Example:

Ms B has an estate valued at £1,000,000 including a £400,000 main residence that she is planning to pass on to her children. She also utilises her annual gifting allowance every tax year and was planning to leave £40,000 of her estate to charity.  

To keep things simple, we are going to assume that she has her full nil rate band and residence nil rate band, as per Case Study 1. 

This means we would calculate Ms B’s inheritance tax liability as follows: 

As the value of gift is below 10% of the baseline value (£67,500), IHT will be chargeable at 40%.

Nevertheless, if Mrs B gifted 10% of her net estate (calculated at £67,500 - detailed above) instead of £40,000, it would have the following impact:

As shown above, the planning in this scenario has not only slightly increased the amount the beneficiaries receive, but also the charity has received a further £27,500. This represents a win-win situation for both parties.  

Can I pay a lower rate of inheritance tax after someone has died?

This may be possible through a Deed of Variation. This is a legal document that allows the distribution of the estate to be altered by the named beneficiaries in the will.

A Deed of Variation can be used to re-direct 10% of the net estate to charity, which means the estate would pay a reduced rate of inheritance tax (36%).

A Deed of Variation needs to be carried out within two years from the date of death for it to be effective from a tax perspective. Furthermore, the relevant paperwork must be signed by all executors and the beneficiaries who may be disadvantaged because of the change.

To help you visualise these numbers, we've put together this Inheritance Tax calculator:

If you are concerned about inheritance tax, or how this relates to charitable giving, why not get in touch with The Private Office and give us a call on 0333 323 9065 or book a free non-committal initial consultation.

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This article is for information only and does not constitute individual advice. The information provided in this article is based on the current allowances and legislation and is subject to change.

The Financial Conduct Authority (FCA) does not regulate estate planning or tax advice.

Inheriting a house, or any type of property, can drastically increase the value of your own estate, but it can also make you liable to pay higher taxes. Specifically, if the home you’ve inherited has gone up in value since you inherited it, you may have to pay capital gains tax if and when you decide to sell it. This can produce a fairly hefty tax bill if there’s been a considerable increase in the sale value, however, there are a few ways you can get yourself off the hook for paying capital gains tax on inherited property, as we’ll outline below.

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What is capital gains tax?

Capital gains tax (CGT) is a tax that applies when an investment sells for more than its original purchase price (its base cost). We usually think of capital gains tax in terms of selling stocks from an investment portfolio, however, it also applies to other forms of investments such as property or tangible assets.

With capital gains tax, you are taxed on the profit - or “gains” - you make on the sale, rather than the whole amount you receive. For instance, if you bought a piece of artwork for £6,000 and later sold it for £36,000, the gain would be £30,000. This is the amount that your CGT liability would be calculated on.  

How much capital gains tax will I pay? 

The rate of CGT you pay is related to your income tax band. There are four tax rates bands:

Nil or basic rate taxpayers (individuals earning an income of £50,270 or lower) pay CGT at a rate of 18% on residential property and other chargeable assets where the disposals take place after 30 October 2024. Higher and additional rate taxpayers (individuals earning over £50,270) pay CGT at 24%.

Note: CGT is not payable on gains made when a residential property is your primary residence. 

What is the capital gains tax allowance?

The capital gains tax allowance for 2024/25 is £3,000. This allowance refers to the amount of gains you can realise from assets or property in a tax year before you are liable to pay CGT. If your assets are jointly owned with another individual, you can combine your allowances, effectively doubling the gains you can make to £6,000 before any CGT is owed.

Note: You are not able to carry forward any unused CGT allowance from previous tax years. 

How can I avoid capital gains tax on inherited property?

There are only two ways to avoid paying capital gains tax on an inherited property:

1. Make the inherited property your principal residence
   Through doing this, you avoid paying capital gains tax when you sell it at a later date. This is because the rules state that you are not liable to pay CGT on a home that is your principal residence (your main home), so long as you have lived in it the entire time you’ve owned it (although there are certain allowable absences including the last 9 months of ownership and work-related absences). This allowance only applies on the condition that you do not let any of the home out, either for living or business purposes. However, letting relief might still be available if the letting of the property has been the taxpayer's main or only property.

    

2. Sell or gift the property as soon as you inherit it
   When inheriting property, the base cost of the property for capital gains tax purposes is uplifted to the value on the date of the previous owner’s death. Therefore, immediate disposal (through sale or gift) of the inherited property would not give rise to a capital gain and therefore no CGT would be payable. However, if the inherited property is retained and increases in value after the date of death, there will be capital gains tax to pay on this increase in value.

Note: Renting out inherited property incurs an income tax charge since it is being used as a means of generating an income.

How do you calculate capital gains tax on inherited property?

Calculating capital gains tax on inherited property is no easy task. Fortunately, we’ve broken it down into clear and easy steps below:

• Calculate your total gain

The total gain is the value you sold the property for minus the value when you inherited it, minus all additional costs spent on the property, including legal fees. You also qualify for relief on enhancements such as adding an extension or conservatory. 

However, where a property is in a poor state of repair and being ‘done up’ prior to selling, this would fall under maintenance and would not qualify for relief.

However, enhancing a property, e.g. adding a extension or conservatory would be. 

Total gain = (value of property when sold - value of property when inherited) - additional costs 

• Deduct your capital gains allowance to get your taxable gain

As mentioned above, the capital gains tax allowance for the 2024/2025 tax year is £3,000. This is the total gain you can make from all your assets or property before you have to pay CGT. If you haven’t used any of your CGT allowance on other assets, you can use the full £3,000.

Taxable gain = (total gain - capital gains allowance) 

• Calculate your tax rate and multiply by taxable gain to get your CGT liability

Any capital gain realised is added onto your income for the tax year to calculate how much CGT is due on each portion of the gain. For example, if your income for the tax year is £45,270 and you incur a taxable gain of £10,000, £5,000 of the gain would fall into your basic rate tax band and would be taxable at 18% and the remaining £5,000 would fall into your higher rate tax band and would therefore be taxed at 24%.

Total CGT = (taxable gain x tax rate)

If you’d like to check your calculations,  HMRC has a capital gains calculator which can do all the work for you.

When is the capital gains tax deadline? 

Any capital gains on the sale of assets made in the 2024/25 tax year must be reported by 31^st December 2025 and the CGT must be paid by 31^st January 2026 via self-assessment. 

However, individuals selling residential property have 60 days from the date of the disposal to report the disposal and make a payment on account for the estimated amount of CGT payable to HMRC. This can be done online or by submitting a paper form. Any further balance will be due by 31^st January 2026 via self-assessment. If the payment on account exceeds the self-assessment liability for the 2024/25 tax year, the excess will be refunded. 

Extra tips for how to avoid capital gains tax on inherited property

• Transfer assets to joint names

If you’re married or in a civil partnership, you can transfer assets into joint names. This means you can combine your tax-free allowance making it £6,000 in 2024/25. However, any transfer you make has to be an outright gift.

• Nominate different principal homes if you're unmarried/not in a civil partnership

Unmarried and non-legally bound couples can each make a different property their main home. So, if you inherit a property and want to avoid paying capital gains tax on it, you can make it your main property, while keeping your former property as your partner’s main home. This means you can benefit from tax relief on both. Married couples and civil partners, on the other hand, are legally obligated to nominate one single home as their primary residency.

How can we help?

If you’re concerned about how much tax you may need to pay on any inherited estate or you simply want to discuss ways you might be able to minimise your tax bills, why not get in touch and see if we can help. We can work with you to advise on the best way to minimise the tax payable on your estate, while helping you build your wealth.

With tax and the regulation around it constantly changing, it helps pay to have the experience of a financial adviser to help guide you to stay on top of your taxes, come what may.

If you want to find out more about how we can help you navigate capital gains tax and inheritance tax, please get in touch and arrange a free consultation.

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Please note that the Financial Conduct Authority (FCA) does not regulate estate planning, tax or trust advice.

This article is intended as information only and does not constitute financial advice.  

The information contained in this article is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing.  Levels, bases and reliefs from taxation may be subject to change.

This article has been updated and re-published following the changes announced at the Autumn Budget on 30th October 2024.
 

Pensions, like most forms of income, incur taxes. However, there are ways to ensure you’re not unnecessarily overpaying in tax, even when you’ve retired.

Do you pay tax on your pension?

The short answer to this question is yes, so long as your pension exceeds the minimum threshold for paying income tax.

Income from a pension is taxed exactly like any other form of non-savings income. Firstly, everyone has a personal allowance, which is the amount of money you’re allowed to earn each year before you start paying income tax. Currently, the personal allowance is £12,570 (though this may be reduced if you have earnings above a certain level), so if you receive less than £12,570 per annum of taxable income, then you pay no income tax. Once your taxable income goes above this level you become liable to pay 20% income tax on taxable income between £12,571 and £50,270 per annum. This then increases to 40% income tax for taxable income between £50,271 and £125,140, and 45% beyond that. These income tax rates are valid as of 2025. For updated and current tax rates, see our latest tax tables. 

It’s worth noting however, under certain circumstances, you do not need to pay tax on all of your pension income. Additionally, there are strategies you can adopt to minimise the amount of tax you pay on your pension. 

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How much will I be taxed on my pension?

Another frequently asked question is “how much tax do you pay on your pension?”. As stated above, the amount of income tax you pay on your pension depends how much income you draw from your pension.

The good news, is that some of your pension is, in fact, tax free. If you have a defined contribution pension, whereby your pension is based on how much you and/or your employer have saved into it — which is the most common kind — then you can take out 25% of your pension completely tax-free, subject to a max of £268,275, this is known as the Lump Sum Allowance (LSA).

It is important to understand that, although possible, this does not need to be taken out as one single lump sum. It is possible to take out multiple smaller lump sums each with 25% tax-free, or just take portions of tax-free cash over time rather than all at once (known as phasing), as long as your pension allows for ‘flexi-access drawdown’. The remaining 75% will be taxed according to the standard rules explained above.

If you are only receiving the new state pension, on the other hand, then you do not need to worry about income tax. As of 6th April 2024, the full new state pension is £230.25 per week, or £11,973 per year  — since this amount is within your personal allowance there will be no income tax to pay. Most people who have worked throughout their lifetime will be eligible for a state pension, although the amount you receive will depend on your national insurance record.

However, if you have income from other sources bringing your yearly income higher than £12,570, then you may be expected to pay income tax.

What other forms of tax for my pension should I be aware of?

Income tax is the main tax you can expect to pay on your pension. Previously the lifetime allowance, stood at £1,073,100 and additional tax may have been due if your pension exceeded this limit. However, in the Spring Budget 2023 it was announced that the charge and the lifetime allowance itself would be removed entirely as of the 2024/25 tax year, while a 0% charge would apply to any excess pension above the lifetime allowance in the 2023/24 tax year. There is, naturally, political risk of legislation changing with regard to this tax charge.

The lifetime allowance has now been replaced by the Lump sum Allowance  (LSA) and the Lump Sum and Death Benefit Allowance (LSDBA).

How much can a pensioner earn before paying tax?  

A pensioner can earn up to the personal allowance before having to pay any income tax, which, as mentioned above, is currently £12,570 for the 2025/26 tax year. This personal allowance is the same for everyone regardless of whether you are retired or still working. Your taxable income from a pension, along with any other income you may have, is added together to determine how much tax you will pay. If your total income for the year is less than or equal to the personal allowance, you will not have to pay any income tax on it. 

How do I drawdown on pension without paying tax?  

While you cannot fully drawdown on your entire pension without paying tax, as we've mentioned there is a portion that is completely tax free. You are entitled to take up to 25 per cent of your pension pot as a tax free lump sum, subject to a maximum of £268,275, which is called your tax free cash or pension commencement lump sum. The remaining 75 per cent will then be taxed as an income. Of course, the benefit is you do not have to take all of your tax free cash in one go; you can take it in stages and combine it with taxable withdrawals to manage your income and stay within a lower tax band.  

How do I avoid tax on an inherited pension lump sum?  

Avoiding tax on an inherited pension lump sum depends on the age of the person who has passed away. If the pension holder was under the age of 75 when they died, a beneficiary can inherit the entire pension pot as a tax free lump sum. However, if the pension holder was 75 or older when they died, any inherited lump sum will be taxed at the beneficiary’s marginal rate of income tax.  

These rules are changing, however. From April 2027 pensions will form part of a person's estate for inheritance tax purposes, regardless of your age.  

This is a complex area and there are different rules depending on whether the beneficiary takes the money as a lump sum or as a regular income from a drawdown scheme.  

How do I avoid paying emergency tax on a pension lump sum? 

Emergency tax is often applied to the first withdrawal you make from your pension if you take it as a lump sum and your pension provider does not have an up to date P45 from you. This is because HMRC will assume that this is a regular monthly income, and they will apply an incorrect tax code, which often results in you paying far more tax than you should. To avoid this, it is often better to take a small initial lump sum and then take further withdrawals after you have received a correct tax code from HMRC. Alternatively, you can apply for a tax refund from HMRC once the tax year has ended. 

How to avoid paying tax on your pension

If you want to mitigate tax on your pension, the only certain way to do it is to ensure that your total taxable non-savings income, including your pension income, is below the personal allowance. However, this will likely not permit you your desired standard of living in your retirement years.

Instead, there are a few tips and tricks for limiting the amount of tax you are liable to pay on your pension. These are outlined below:

Only withdraw the amount you need each tax year

Of course, you should take out as much as you need to live a comfortable life, but you might want to keep an eye on staying within certain tax thresholds. For example, if you are careful to take out no more than £50,270 in the current tax year, including any other income sources, you will only need to pay 20% income tax. However, if you were to take out £50,271 or more, you’d pay 40% on the amount over £50,270, up to the next tax threshold. 

Note that at retirement stage, you aren't required to draw down on your pension income to put into savings. This means it can be more financially beneficial to withdraw less, or none, and stay within a low tax range, rather than withdraw more and have to pay substantially more tax.

Take advantage of a drawdown scheme

Drawdown allows you to vary your income from year to year, meaning you can opt to keep it below a certain tax range in a given year. This is not possible for you, however, if you have an annuity, since annuity income cannot be varied at will. Bear in mind that drawdown does come with some risks, so always check with a financial advisor before you pursue it as an option.

Don’t draw your pension in one go

As is evident from the points above, staggering your pension so that you receive less on an annual basis ultimately means you will pay less tax. While you might be tempted to empty your pension pots in one go, it will mean paying income tax on that amount in one year. In most cases, this would be a poor decision from a tax perspective as it may result in your income falling into the higher tax rate bands and triggering a significantly larger tax bill.

Phasing your 25% tax free cash 

In the event that you need to draw more than £50,270 from your pension, you would be liable for 40% income tax on any further income until the next tax band or if you go over £100,000 and hit the 60% tax trap. It is possible, in this instance, to take smaller amounts from your tax-free cash to top up your income when you reach these limits. When planned with care, this can be an excellent retirement income strategy to ensure you do not pay higher rates of income tax.

The importance of Pension Freedoms

With the introduction of Pension Freedoms in 2015, this allows far more flexibility for an individual when they come to draw their pensions.  An individual can now draw their pension from minimum pension age onwards, when and if they like, in any portion that they like. As well as this flexibility allowing an individual to tailor their income needs around their chosen lifestyle, it also allows far more flexibility with regards to tax planning, including income tax, as well as inheritance tax, which are all intertwined when planning in this nature. It is therefore important that your pension schemes have adopted the Pension Freedoms to ensure that you have absolute flexibility both on drawing an income as well as on death. It is important to note that not all pension schemes have adopted modern flexibilities. If you are unsure, get in touch.

So, the only way to truly avoid paying tax on your pension is to ensure your pension withdrawals (including your state pensions) do not exceed £12,570 per year.

Ways to reduce tax on your pension however include:

• Not withdrawing more than you need from your pension each year.
• Utilising a drawdown scheme so that you can vary your yearly pension income.
• Avoid drawing large pensions in one go.
• Phasing tax free cash.

How can we help?

The Private Office offers advice from one of our experienced advisers, on how best to manage your pension, including how to avoid paying unnecessary extra tax. Get in touch to arrange a free consultation.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up which would have an impact on the level of pension benefits available.  

Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change. You should seek advice to understand your options at retirement.

The Financial Conduct Authority (FCA) does not regulate estate planning or tax advice.

Inheritance tax (IHT) is a tax levied on an estate before the assets are passed to the beneficiary via inheritance or as a gift. Although IHT is paid on death, it can also apply to some gifts that are made before the person dies. If you’re making a financial gift, you need to understand whether the gift is tax-free, or whether it will create a tax bill, either immediately or further down the line. That’s why it’s critical to understand the 7 year gift rule in inheritance tax. 

Alongside these complexities, the government will announce the Autumn Budget on 30th October. The Labour government faces the certainty of addressing a £22 billion funding deficit, which will result in changes to taxes and spending. Inheritance tax is one area where key adjustments are expected to boost tax revenues. This article will examine the current rules and explore the potential changes that could be introduced. 

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Introduction to inheritance tax 

Before we explain the 7 year gift rule in inheritance tax, it’s important to provide a basic overview of what we mean by the term “inheritance tax.” 

Simply put, inheritance tax is a tax on the estate (i.e. money, possessions, property) of a person who has died. It's a one-off tax that must normally be paid within 6 months of the deceased's death (exceptions may apply). IHT is also referred to as a cumulative tax because it takes into account earlier gifts when assessing the amount of tax that is due. 

Currently, the nil-rate band (i.e. tax threshold) for inheritance tax is £325,000 for individuals, or a combined nil-rate band of £650,00 for married couples or civil partnerships in addition to the main residence nil-rate band (RNRB) currently £175,000 (per individual), whereby no tax is paid on amounts at or below this level. However, any balance over this threshold could be subject to a tax charge which at present, is a standard inheritance tax rate charge rate of a hefty 40%, or 36% where 10% of the net estate is left to charity. Other tax rate charges may apply and are discussed later in this article.

You’re also going to be hearing the term “gift” throughout this article. But what is a gift? Forget about ribbons and wrapping paper. HM Revenue and Customs (HMRC) defines a gift as something which has a value (i.e. possessions, money, property), or a loss of value that occurs when something is transferred (i.e. if you sell a house for less than it’s worth to your children, the difference in value is defined as a gift). 

For more information about general inheritance tax-related topics, download our exclusive guide. 

Understanding the 7 year gift rule in inheritance tax 

So, what is the 7 year rule in inheritance tax? Essentially, there are a range of gifts that are exempt from inheritance tax. Everything else is defined as either a chargeable lifetime transfer (CLT), which is for gifts into a discretionary trust that may be subject to an immediate 20% IHT charge (if paid by the trust, or 25% if paid by the settlor), or a potentially exempt transfer (PET) where the gift will only be completely tax-free if you live for 7 years after gifting it (assuming that the gift has been given to an individual, rather than a business or trust). If you die within 7 years of gifting the asset, then the gift will count towards your nil-rate band, as we mentioned above, meaning that it may still be subject to IHT. After 7 years, the gift doesn’t count towards the overall value of your estate. This is known as the 7 year gift rule in inheritance tax. However, the 14 year rule may mean that a failed CLT brings a previous PET back into the estate for assessment.

What is the gift inheritance tax threshold? 

As we stated earlier in the article, the inheritance tax threshold (also referred to as the nil-rate band) is £325,000 plus the £175,000 RNRB (if available). This is the total amount of your estate that you can pass onto your inheritors without paying IHT. However, if the value of your estate exceeds the gift inheritance tax threshold, you’ll have to pay inheritance tax on anything above the threshold. For example, if your estate is valued at £450,000, you will only need to pay inheritance tax on £125,000 (assuming no RNRB is available). 

Inheritance tax-free gifts 

If you die within 7 years of gifting an asset to an individual, the 7 year gift rule in inheritance tax means that the beneficiary may be required to pay IHT. If you want to protect your wealth for your loved ones, it’s important to remember that some gifts don’t incur any inheritance tax charges if you give them away while you’re still living. 

Inheritance tax-free gifts include: 

• Gifts to your partner or spouse – any gifts you make to your UK-domiciled spouse/civil partner are free from inheritance tax, and some gifts to non-UK domiciled spouse are also exempt.
• Wedding gifts – in a wedding/civil partnership, you can gift (free from inheritance tax) up to £5,000 to a child, £2,500 to a grandchild/great grandchild, or £1,000 to anyone else.
• Gifts from your income – as long as the gift doesn’t affect your normal standard of living, you can make gifts out of your normal income, i.e., Christmas/birthday/anniversary presents, regular payments, life insurance policy premiums, etc.
• Gifts to assist with family maintenance – gifts helping your relatives (i.e., ex-spouse/former civil partner, a child, or a dependent relative) with living expenses are free from inheritance tax.
• Gifts to charities – you can make gifts of any value to charities, universities, museums, and community sports clubs without paying inheritance tax.
• Gifts to political parties – finally, gifts you make to political parties are exempt from inheritance tax, assuming that the political party in question has at least 2 members elected to the House of Commons and 1 member has been elected with 150,000 votes in a general election. 

There’s also an annual exemption for inheritance tax-free gifts worth up to £3,000. In other words, every year you can gift up to £3,000 free from inheritance tax. Furthermore, you can carry over an unused annual exemption from the previous year, provided that the current year's allowance is used first. Remember that gifts valued above the gift inheritance tax threshold of £3,000 are subject to IHT. In addition, there’s the small gifts exemption, which enables you to make an unlimited number of small inheritance tax-free gifts each year, outside of your annual exemption. These gifts are for up to £250 each, provided that you have not already used another exemption for the same person. 

What is taper relief? 

Another key aspect of the 7 year rule in inheritance tax, is taper relief. Essentially, taper relief comes into play if the benefactor doesn’t live for the full 7 years. It means that if the benefactor survived for 3 years or longer, the inheritance tax payable is applied on a sliding scale. As you can see, it’s better to give gifts earlier, rather than later. 

Remember, taper relief only applies to the amount of tax the recipient has to pay on the value of the gift that’s above the nil-rate band. 

For example, suppose Person A gifted £600,000 to their son in May 2016. Person A died in March 2021, having left their £1,200,000 estate to their son as well. Because Person A died within 7 years of making the gift, it contributes towards their nil-rate band. IHT is due on the value of the gift above the nil-rate band (£600,000 - £325,000 = £275,000), but because Person A died 4-5 years after making the gift, the amount of IHT their son is required to pay was reduced by 40%. So, the overall amount of inheritance tax that Person A’s son needed to pay was £66,000 (£275,000 x 24% = £66,000). 

Because the gift used up Person A’s entire nil-rate band, their son will need to pay inheritance tax on the estate at the full 40% IHT rate as well. This means that the estate of Person A had to pay £480,000 (£1,200,000 x 40% = £480,000) before the assets could be distributed. 

There are separate rules around property, which means a higher nil-rate band is available for some, known as the residence nil-rate band. The residence nil-rate band is only applicable to direct decedents, so it’s important you understand the rules depending on who is receiving the gift, how the tax is applied to the gift and how these different rules apply to you.  

Who pays inheritance tax on gifts? 

If you end up incurring IHT on gifts because of the 7 year gift rule in inheritance tax, you’re probably wondering who’ll actually need to make the payment to HMRC. It’s a legitimate question. 

If your estate is above the nil-rate band, funds from your estate will be used to pay inheritance tax to HMRC. This will be dealt with by the person who is dealing with the estate (if there’s a will, this person is referred to as the executor). When it comes to gifts, if the benefactor dies before 7 years have elapsed, the recipient of the gift may have to pay IHT. 

Potential Budget Changes:

There is speculation that the Labour government may overhaul the 7 year rule as part of efforts to raise additional revenue. One possible change could be extending the seven-year period to ten years, which would increase the likelihood of gifts being subject to IHT. Additionally, past proposals from a 2020 All Party Parliamentary Group suggested introducing a 10% tax on lifetime gifts above a £30,000 annual allowance, regardless of when they are made.  

If implemented, such reforms would fundamentally change the way potential exempt transfers work and potentially impact individuals looking to pass on wealth during their lifetime. Families may need to reassess their estate planning strategies, particularly if they plan to make significant gifts to reduce the value of their taxable estate. 

How can we help? 

The gift inheritance tax threshold along with the broader 7-year gift rule, is a fairly complex topic. With potential changes coming in October, these rules may be amended or significantly altered, leaving many unsure of the best course of action. If you would like to discuss your specific situation and explore inheritance tax planning options, please contact The Private Office for a free initial consultation with one of our financial advisor for a free initial consultation.

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The Financial Conduct Authority (FCA) does not regulate estate planning, tax or trust advice.