Case study - Hetty
Hetty (73) is divorced with 3 adult children (Peter, Simon and Betty), who are higher rate taxpayers.
Her home is mortgage free and valued at £1.3m. She has savings of £400,000, plus a drawdown pension valued at £650,000.
In terms of retirement income, Hetty has a full State Pension of £11,973 per year, which is topped up by regular interest and dividends taken from her pension and savings.
Hetty’s current IHT liability
Hetty’s children will inherit her estate when she dies. If she died in the 2025/26 tax year, her IHT liability would be calculated as:
| Estate (house + savings) | £1,700,000 |
|
Less IHT nil rate band Less residence nil rate band |
-£325,000 -£175,000 |
| Taxable estate | £1,200,000 |
| IHT on taxable estate @ 40% | -£480,000 |
| Net estate | £1,220,000 |
| Drawdown pension pot | £650,000 |
| Amount payable to children | £1,870,000 |
As Hetty is under the age of 75, her children can inherit her pension without having to pay income tax on any amounts withdrawn.
If Hetty dies in 2 years’ time
Hetty dies age 75 in January 2028. By this point, announced changes to IHT on pensions have been implemented.
Assuming no changes in the value of her assets, the overall tax her family pays will increase by £500,383 to £980,383:
| Estate (house + savings) | £1,700,000 |
|
Less 72.34% of IHT nil rate band * Less residence nil rate band** |
-£235,106 £0 |
| Taxable estate | £1,464,894 |
| IHT on taxable estate @ 40% | -£585,958 |
| Net Estate | £1,114,042 |
| Drawdown pension pot | £650,000 |
| Less 27.66% of IHT nil rate band * | -£89,894 |
| Pension chargeable to IHT | £560,106 |
| IHT on pension @ 40% | -£224,042 |
| Net pension after IHT | £425,958 |
| Income tax on pension (higher rate @ 40%)*** | -£170,383 |
| Net payment | £255,575 |
| Amount payable to children | £1,369,617 |
* The IHT ‘nil-rate band’ (NRB) is now apportioned between the pension (27.66%) and wider estate (72.34%).
** The ‘residence nil-rate band’ (RNRB) is tapered away by £1 for every £2 that the estate exceeds £2m. With the inclusion of the pension, the taxable estate is £2.35m and the RNRB is reduced to £0 (£350,000 / 2 = £175,000).
*** As death occurred after age 75, pension withdrawals are now taxed as the children’s income.
| PET* | £444,000 |
| Less IHT nil rate band | -£325,000 |
| Taxable amount ** | £119,000 |
| Estate (house + savings - ER loan) | £1,184,795 |
|
Less IHT nil rate band Less residence nil rate band*** |
£0 -£175,000 |
| Taxable estate | £1,009,795 |
| IHT on PET + taxable estate @ 40% | -£451,518 |
| Net Estate | £733,277 |
| Drawdown pension pot | £650,000 |
| IHT on pension @ 40% | -£260,000 |
| Net pension after IHT | £390,000 |
| Income tax on pension (higher rate @ 40%) | -£156,000 |
| Net payment | £234,000 |
| Amount payable to children | £967,277 |
* Death occurred within 7 years of making the PET of £444,000, so is chargeable to IHT and fully uses up the NRB of £325,000. There is no NRB remaining to be set against the wider estate or pension.
** Death occurred within 3 years of the gift, so doesn’t qualify for taper relief. The amount of the gift exceeding the NRB is charged at the full IHT rate of 40%.
*** For the purposes of the RNRB taper, the gift is excluded. The estate (including the pension) is now below £2m and the RNRB is fully restored.
- The net amount Hetty’s children receive on death has reduced to £967,277 (a drop of £402,340). However, the gift of £450,000 2 years previously means that they are £47,660 better off overall.
- In addition, the IHT charge has dropped significantly, so the children need to raise less money to pay the bill. This reduces the potential for late payment interest - charged at 7.75% (base rate + 4.5%) if it’s not paid within 6 months of death.
If Hetty lives for longer
Were Hetty to survive 7 years, the £450,000 gifted to her children falls out of her estate completely.
By this time, the outstanding lifetime mortgage loan would increase to £722,602. However, this rise would be partly offset by any house price growth in the intervening years. Furthermore, any outstanding loan will be deducted from the estate, further reducing the potential IHT bill by £289,041 (40% of £722,602).
Comment
Use of a lifetime mortgage loan allows Hetty to provide a greater total inheritance to her children, with a substantial portion released well in advance of her death. This enables the children to benefit from earlier access to the cash and for Hetty to see them put the money to good use during her lifetime.
The gift also helps simplify the administration of the estate – as it fully used up the NRB, this did not need to be apportioned between the pension and estate assets, which could have caused delays and risked late payment interest becoming chargeable.
Important information
Please note this is for general information only and is based on LV's understanding of the relevant legislation and regulations and may be subject to change.
The tax treatment of benefits depends on individual circumstances and may be subject to change in the future.
The use of this document is at your own risk, and the content should not be used for the provision of professional advice.
LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.