Long Read  

Happy birthday to £3,600 or more

Regular premium IHT planning 

If a baby born on April 6 2001 had £3,600 paid into their pension every year since birth, say by their grandad, they would now have a healthy pension pot at their 21st birthday.  

At 4 per cent growth and paid annual in advance, they would have around £120,000. Grandad will have been able to make those payments within his annual inheritance tax allowance, removing a touch under £60,000 from his estate and potentially saving around £24,000 in IHT.  

And while I am sure the thought of his grandchild having access to a six-figure sum at the age of 21 may put a shiver down his spine, he is likely to be reassured that the pension tax rules prevent his grandchild accessing that amount of money until a sensible age. That is if you deem 57 to be a sensible age, of course. 

A pensioner who got more than 500% tax relief

When you have a profit on an insurance bond gain that has built up over many years, the government acknowledges that it would be unfair to tax the whole gain in a single tax year. To reflect this you get taxed in a way that is broadly equivalent to what you would have paid if you had been taxed on your average gain each year.

Your average gain, is known as your 'top slice', and the more of it that is in your basic rate tax band the more top-slicing relief you get. If all your slice is in the basic rate tax band, your relief removes any liability to higher-rate tax on your bond gain. Those with onshore bond gains get a 20 per cent tax credit and so overall would have no tax to pay on their encashment.

You pay higher rates of tax based on the amount of the top-sliced gain (your average annual gain) that is over the basic and higher-rate threshold, which is currently £37,700 and £150,000 respectively.  

Pension contributions increase your basic and higher-rate thresholds by the amount of the contribution. This means you can move some of your sliced gain from 45 per cent tax into 40 per cent tax or 40 per cent tax into 20 per cent tax. The more of the slice that is in a lower tax band the higher your top-slicing relief. Pension contributions get you tax relief but can also get your top-slicing relief.  

This is exactly what happened to one retiree I heard of – let us call her Irene, a 72-year-old retiree, who was in receipt of £8,000 state pension income and £38,000 income from rental properties, who had held an onshore investment bond for 37 years, with a gain of £250,000.

It was easy enough to establish her tax liability for the year prior to any encashment. This was the income above the personal allowance multiplied by 20 per cent – in this case, a liability of £6,686.