The scrapping of the lifetime pension allowance on April 6 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 inheritance receipts continuing to rise, do pensions now provide the wholesale solution for the estate planning challenges that individuals currently face?
A recent survey 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.
The removal of the LTA is not a panacea for intergenerational financial planning.Close to 90 per cent 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 that will not be liable for IHT when they die.
Pension drawbacks
However, the removal of the LTA is not a panacea for intergenerational financial planning.
Importantly, while 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 a year.
This materially reduces the ability to use a pension to mitigate IHT for those with substantial assets.
While gifting is an option to reduce IHT, with the ongoing cost of living crisis, this is becoming less popular.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There are also limits on how much can be withdrawn without being taxed: only 25 per cent of a pension can be taken out before withdrawals start to get taxed as income.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.
BR-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 BR, 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 BR.
While this does not extend to listed companies, the government included trading companies admitted to the Alternative Investment Market as able to qualify for BR. 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 BR-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 BR-qualifying investments in any single year.
As a means of mitigation IHT, BR-qualifying investments also compare favourably to gifting – that is, giving away money during an individual’s lifetime.
While gifting is an option to reduce IHT, with the ongoing cost of living crisis, this is becoming 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 seven years for the value of the gift to be outside a client’s estate. BR-qualifying investments allow clients to keep shares in their name and keep hold of their wealth should they need it.
Although sentiment towards scrapping the LTA is largely positive, it is important to consider a holistic approach.Additionally, in contrast to gifting, after only two years the value of the investment can be IHT-free.
In terms of how to make BR-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 that can provide access to BR-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 BR 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 intergenerational 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 BR-qualifying investments.
David Kaye is chief executive of Puma Investments
