As the UK government prepares to change the way pensions are treated for inheritance tax purposes from April 2027, savvy savers and investors are turning to estate planning strategies to reduce their tax bills and boost their loved ones' pension pots. One way to achieve this is by making use of gifting allowances and surplus income exemptions, which can allow regular income payments to be gifted tax-free.
According to Sarah Coles, head of personal finance at AJ Bell, regular income payments from pensions, including those from annuities or drawdown arrangements, are generally considered income and can be given away under the surplus income exemption. This means that savers can withdraw money from their pension and regularly gift it to their loved ones, who can then claim pension tax relief when putting it into their pension pot.
While income tax may be payable on the pension withdrawals, the added bonus is that the person receiving the money can avoid a larger inheritance tax bill down the line. Financial adviser Lisa Conway-Hughes notes that this is a way of building a family inheritance tax plan and moving the pension down the generations.
To qualify for the surplus income exemption, gifts must be part of normal expenditure, and the giver must be able to maintain a normal standard of living after making the gift. The gift must also come from 'normal' income, which includes pension, rental, and dividend income. Detailed records of any gifts made should be kept to make it easier for the executors of the will to administer the estate.
When giving away money from a pension, it's essential to note that the gifts out of surplus income exemption will only apply to money from regular income, such as regular pension withdrawals. Ian Dyall, head of estate planning at wealth manager Evelyn Partners, advises that the funds must come out of regular pension withdrawals and not from taking 25% tax-free cash as a lump sum.