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Heirs and graces

Continuing in our series on the new opportunities offered by the new defined-contribution tax regime, in this article we look at how stakeholder and personal pensions could be used in inheritance tax planning.

We all know how inheritance tax mitigation forms an important part of the financial planning cycle for many clients and, with the current nil-rate threshold at £242,000, more and more high-net-worth clients need to take action to reduce the potential IHT liability.

Until now, professional advisers – including solicitors and IFAs – have made use of a number of tools available to help in IHT planning. It is vital that a will is made and reviewed regularly to ensure that it matches the changing circumstances of the client and any legislative alterations.

In addition, clients should take advantage of exempt transfers between spouses, current annual exemptions and small gifts.

Other tools include potentially exempt transfers, gift inter-vivos policies and the appropriate use of trusts.

However, under the new regime, it is now possible to use stakeholder or personal pensions. Non-earners, including children, are eligible to contribute up to £3,600 a year to a stakeholder or personal pension. This allows relatives, such as parents, grandparents, godparents or aunts and uncles to contribute to younger family members&#39 pension arrangements.

Another option would be for a working spouse to contribute on behalf of a non-working spouse.

Stakeholder and personal pensions could be used to absorb the annual gift exemption of £3,000 per donor.

Until now, it has been relatively common for parents or grandparents to use up the annual exemption by making cash gifts to children or grandchildren.

However, now a stakeholder or personal pension can be taken out for the child with the grandparent funding the contributions. The net cost to the donor will be £2,808 and the provider will then claim the basic-rate tax from the Inland Revenue, resulting in a gross amount of £3,600. For IHT purposes, the net figure of £2,808 is taken as the sum leaving the donor&#39s estate.

It should be noted, however, that the tax relief applies to the member, not the contributor. A grandparent paying higher-rate tax cannot claim back the higher-rate relief. The annual exemption can be used each year in this way, providing a valuable savings pot for the child – and one that cannot be accessed until 50, unlike cash gifts.

Another exemption that can be used under the new regime is for contributions to be paid out of normal income. There would have to be clear evidence that the contribution was coming out of income rather than capital and that the money was being paid on a regular basis.

If the contributions do not qualify under the annual gift exemption or normal expenditure from income, then they may be considered as Pets. There is still some debate surrounding Pets and further clarification is required from the Inland Revenue.

When a stakeholder or personal pension is being taken out on behalf of a minor, the Inland Revenue has specific rules. The legal guardian of the child must take out the stakeholder or personal pension. This includes completion of the relevant application forms and taking responsib-ility for the contract until the child is 18.

The legal guardian must also sign a separate declaration stating that they understand that the contributions paid to the contract may only be returned to the member in the form of benefits payable under the rules of the personal or stakeholder pension scheme.

So a double-edged opportunity to come out of the new tax regime. Not only can grandparents help to provide for their grandchildren&#39s future but they can also reduce the IHT tax burden.

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