Time to talk about pensions before IHT gamechanger

TIME TO TALK ABOUT PENSIONS BEFORE IHT GAMECHANGER

“In this world nothing is certain, except death and taxes,” the US statesman Benjamin Franklin famously wrote in the 19th century. Over 200 years later, the UK’s 2024 autumn budget brought these two certainties together, by proposing that pensions will become liable for inheritance tax (IHT) from April 2027. 

Pensions have not been subject to IHT, making them a key part of estate planning. Anyone saving into a defined contribution scheme pension could do so tax free up to their annual allowance which stands at £60,000 in 2025, and the resulting pot of money could be passed to their heirs free of tax, on death.

The Chancellor of the Exchequer ushered in a significant change to pension fund rules with regards to IHT. The proposed amendment will impact anyone who has been building up pension assets with an eye to passing them on to beneficiaries. While still subject to final consultation, it was a landmark shift and has caused many people to rethink how best to save for retirement.

Many people have accumulated substantial sums in their pensions. If you’ve been using your pension for estate and IHT planning, you may wish to reconsider your options, since the proposed change suggests pensions will become liable for IHT from April 2027. 

For example, should you take more tax-free cash from your pension now and gift it to reduce the value of your estate? Or should you start drawing down, pay income tax and use the net income to supplement your lifestyle? Finally, should you opt for other tax-efficient investments available? It might be better to save into an investment with a tax incentive like the Individual Savings Account (ISA), especially if  you have used up your annual allowance for pension contributions.

FROM ACCUMULATION TO DECUMULATION 

Pensions are nothing if not complex. You spend your working life accumulating wealth, saving into your pension, investments and other assets. When you stop working, you enter a new phase – known as decumulation – where you draw down these assets to fund your retirement. 

When you draw down your pension you have different options. For a start, you can access up to 25% of your pension as tax-free cash at any time from the age of 55 (drawing up to a maximum of £268,275). After that, the remainder of your pension will be taxed as income when you receive it.

Typically, there are two options for drawing down income – one guaranteed, the other flexible. A defined benefit pension scheme from an employer typically provides a guaranteed income. Alternatively, if you have a defined contribution scheme, you can guarantee your income for life by buying an annuity with some or all your funds. 

Turning to the flexible option, if you have a defined contribution scheme you can choose how much income to take and when. This allows you to tailor your income to your lifestyle but your pension will remain invested in the markets and the value of the overall fund will fluctuate accordingly.

WHAT TO DO NOW

Following the 2024 autumn budget much has changed, and you may want to reconsider both how you save for retirement and how you draw down your pension. What hasn’t changed is that you can still pass your pension free of IHT to your spouse under the spouse exemption. Whilst  still under final consultation, it is proposed that from April 2027, other beneficiaries will be subject to IHT.  On top of that they may have to pay an income tax charge when they take any money out, which could be even higher than the IHT rate.

One way to minimise the tax impact could be to pass funds withdrawn from your pension to your loved ones during your lifetime. For instance, you can gift an unlimited amount of money to someone and providing you live for seven years there will be no IHT payable. If you die before seven years is up, the rate of IHT due for some larger gifts can fall steadily from year three up to the final seventh.

Alternatively, you can gift any surplus income which  you don’t need. However, to qualify the gifts must be made from income not capital; they must not impact your standard of living; and they must be in a regular pattern such as monthly or annually. There’s no cap on the gift, providing you meet these rules.

WHICH OPTION IS RIGHT FOR YOU?

All in all, there’s a lot to consider. If you’re still saving, or accumulating, your pension you might want to save some of your contributions into an ISA instead. If you’re at retirement age, you could take some or all the tax-free cash that you’re allowed from your pension and gift that to your children.

Everything depends on your personal circumstances, what retirement lifestyle you want and what you want to leave to your loved ones. There’s much to think about and you have big choices to make. Whilst  death and taxes may be certain, even after the proposed 2027 rule changes you have numerous options. 

Get in touch with a Brown Shipley Client Advisor to learn more or download our ‘Your Post-Budget Guide to Pension Planning’. 

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