Received an inheritance? Here’s why you should consider boosting your pension

After receiving an inheritance, it can be difficult to know how to use it. You may still be grieving the loss of a loved one or feel overwhelmed by the different options. However, using some or all your inheritance to boost your retirement savings could make sense.

First, don’t rush into making financial decisions about your inheritance.

If the inheritance is in a cash account with an authorised bank or building society, it will usually be covered by the Financial Service Compensation Scheme (FSCS). This means your money is protected, even if the financial institution fails.

Usually, the FSCS protects deposits of up to £85,000 per person, per bank or building society. However, it also protects up to £1 million for six months for qualifying temporary high balances, including inheritances. If your inheritance exceeds this amount, you should think about spreading the money across several different banks.

When you feel ready to make decisions about your inheritance, here are four fantastic reasons why adding money to your pension should be part of your considerations.

1. Boosting your pension could lead to a more comfortable retirement

Adding to your pension now means you could enjoy the retirement lifestyle you want. Whether you’re hoping to travel, spend time with grandchildren, or enjoy hobbies, boosting your pension could provide more financial freedom later in life.

2. You receive tax relief on pension contributions

To encourage people to save for their future, the government provides tax relief when you contribute to your pension. So, your deposit will instantly benefit from an immediate boost.

Tax relief is given at the highest rate of Income Tax you pay. If you deposit a lump sum of £20,000, as a basic-rate taxpayer, you’d receive £5,000 in tax relief.

As a higher- or additional-rate taxpayer, you would need to complete a self-assessment tax return to claim your full entitlement.

3. It’s a tax-efficient way to invest

Money held in your pension is typically invested. As your pension can grow free from Capital Gains Tax, it provides a tax-efficient way to invest for the long term.

While returns cannot be guaranteed, historically, the market has delivered returns over longer time frames. As your pension could be invested for decades, this provides an opportunity for the value of your retirement savings to grow in real terms.

4. It could reduce a potential Inheritance Tax bill

After receiving an inheritance, you may be thinking about what you will leave behind for loved ones. If Inheritance Tax (IHT) is a concern, using your pension to effectively pass on wealth could make sense.

Your estate could be liable for IHT if it exceeds the nil-rate band, which is £325,000 for the 2023/24 tax year. If you will be leaving your main home to direct descendants, you may also be able to use the residence nil-rate band, which is £175,000 for 2023/24.

Crucially, pensions aren’t usually considered part of your estate for IHT purposes. How an inherited pension is taxed will depend on when you pass away and how the beneficiary accesses the money, but it could be significantly below the 40% IHT rate.

Remember, you cannot usually access pension savings until you’re 55

A drawback to contributing more to your pension is that the money won’t be immediately accessible.

Usually, you cannot access pension savings until you are 55, rising to age 57 in 2028. So, you wouldn’t be able to dip into it if you wanted to increase your income sooner or cover emergency costs.

Before you boost your pension savings, it’s important to review your wider financial circumstances. If you don’t already have a financial safety net, it could make sense to keep some of your inheritance in a cash account to improve your financial resilience. Or if you want to invest but access the returns before you’re 55, you should look at the alternative options, such as a Stocks and Shares ISA.

Before you decide how to use your inheritance, take some time to think about what your goals are and assess how financially secure you are.

How much could you tax-efficiently add to your pension?

The Annual Allowance limits how much you can tax-efficiently add to your pension each tax year. If you exceed the Annual Allowance, you won’t receive tax relief on the portion above the threshold and you could face an additional charge.

The Annual Allowance increased from £40,000 to £60,000 (or 100% of your annual earnings) for the 2023/24 tax year.

Importantly, if you have a large lump sum you want to deposit in your pension, you can carry forward unused Annual Allowance for up to three years and still benefit from tax relief. So, if you want to boost your pension with an inheritance, reviewing your contributions over the last few years could mean you make the most of your Annual Allowance.

If you have already taken an income from your pension or you are a high earner, your Annual Allowance may be lower. Please contact us if you’re not sure how much you can tax-efficiently add to your pension.

Contact us to create a plan that suits you

If you’ve received an inheritance and aren’t sure how to use it to reach your goals, give us a call. We’ll work with you to understand how an inheritance could support short- and long-term financial security, as well as your ambitions.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.

The Financial Conduct Authority does not regulate estate or tax planning.