Pensions and Inheritance Tax

For the past few months since Labour’s Budget, I have been asked by many people about the changes to Business Relief, Agricultural Property Relief, Employer National Insurance and Capital Gains Tax (CGT).  However, the question that I have been asked above all is the proposal that pensions will be included in the estate for Inheritance Tax (IHT) purposes from 2027.

 

What has been announced?

 

The Budget in October 2024 stated that there will be a consultation into whether pensions will be included in the estate for IHT purposes from 6 April 2027.  The points noted were as follows:

 

• IHT will be applied to ‘unspent’ pensions and death benefits within registered pension funds.
• This applies to Defined Contribution (DC) pensions and lump sums payable in Defined Benefit (DB) pensions.
• Pensions and death benefits payable to a spouse continue to be exempt from IHT.
• Pension Trustees and providers will be responsible for calculating and paying the IHT liability to HMRC.
• There could be potential ‘double taxation’ applied to the beneficiaries of the pension. At the moment, pension funds are passed to beneficiaries free of tax if death occurs before age 75.  Benefits becomes taxable at the beneficiary’s marginal rate of Income Tax if death occurs after age 75.

 

This is still under consultation with no conclusions made.  It may not happen, or it could be in a very different way to the initial proposal above.  Certainly, with the opposition that the Government are already facing after less than a year in office to the other measures it has introduced, many commentators are suggesting that it could be political suicide to apply more pressure to an already burdened taxpayer.

 

Also, as pensions are held in a Discretionary Trust, bringing these assets into the estate for IHT purposes could be very problematic and could change Trust legislation as well as pension legislation, in what is already a very complex space.  Could it be a better option if they are going to apply an additional tax on death, to have a pension death benefit charge?  Perhaps going back to a percentage tax charge on death, formerly introduced by Gordon Brown, which we had until 2015?  Could this be a simpler option?

 

What happens if the estate is valued over £2million?

 

Once the value of the estate increases above £2million on death, you start to lose your Residential Nil Rate Band (RNRB) by £1 for every £2 of value over £2million.  So, what if a couples’ estate is worth £2million on second death, and there is a £700,000 pension pot?  What difference will this make to the IHT situation?

As you can see, the IHT bill increases by £420,000, or 105%, just with the inclusion of the pension value in the estate in this scenario!

 

Potential solutions

 

If the new proposed changes do come after 2027, what could you potentially do to mitigate your exposure to IHT? Please remember that this list is not exhaustive, of course.

 

• Don’t forget that the spousal exemption on first death still applies, so if pensions are inherited by a spouse, IHT is not payable until they die, and it is determined by the value of their estate at that time, and their applicable nil-rate bands.
• You can withdraw your tax-free cash entitlement (up to the Lump Sum Allowance mentioned later in this article) and move it into other areas such as trusts, or you can make gifts or spend the proceeds.
• With the remaining taxable element of your pension, you can draw this down in your lifetime and spend or gift it. This can be problematic of course, as none of us know how long we will live and what we will require, for example if we end up needing long-term care.
• Investing in an annuity is an option to be considered, as once the purchase has happened, the money is spent in exchange for an income paid for the rest of your life. Although annuities are not as popular as they once were, annuity rates have improved as the interest rate has increased, and they should be considered as part of a retirement strategy.  You can use part of your pension for this and maintain flexible access with the remaining amount.
• You could take out a ‘Whole of Life Assurance’ policy to provide a lump sum into trust on your death, outside of your estate for IHT purposes, and available to your family, either as a means to pay the IHT on the estate, or as an additional legacy. This of course can be expensive and is subject to medical underwriting at the point of application.  However, this is another consideration that should be discussed as part of the strategy and can be very effective in the right circumstances.

 

Are pensions still worthwhile?

 

In short, absolutely yes they are!  For now, pensions still represent a valuable part of financial planning.  They still have valuable tax benefits for individuals and businesses outside of the IHT issues that may be introduced and should be one of the main core foundations for good financial planning.  Some of the benefits can be summarised as follows:

 

• Pensions are still outside of the estate for IHT purposes until the new rules come in (if they come in at all…).
• Pensions are still one of the most tax efficient wrappers to hold money in, benefitting from very favourable CGT and Income Tax treatment.
• You still have 25% tax-free entitlement up to the Lump Sum Allowance (LSA), currently £268,275.
• Pensions are still tax free for beneficiaries if death occurs before age 75.
• Pensions are still a key way of extracting profit for business owners alongside salary and dividends and must be considered for all businesses paying Corporation tax unnecessarily.

 

Conclusion

 

We are urging people to not make any decisions that could turn out to be detrimental in future.  The Budget proposals are not all set in stone and are still subject to ongoing consultation.

 

If the rules do change and pensions fall part of the estate for IHT purposes, or if a death benefit taxation system is reintroduced, assessing your options and taking financial advice at that time is essential.  It may be that you consider withdrawing your tax-free cash entitlement and spending, gifting, or moving money into trust, or other tax wrappers.  It is vital that these options are assessed and evaluated before any decisions are made.

 

There are many other considerations with IHT planning that need to be discussed as applicable, but first and foremost for many people their pension is one of the primary sources of retirement income, not just as a tool for mitigating IHT.  However, it has made pensions much more attractive to many and it would be a shame if a new taxation burden is introduced.

 

As stated in previous articles I have written, at Golden Oak Wealth Management, we advocate the use of multiple tax wrappers to diversify your exposure to any tax rules, rates and allowances.  This allows our clients to mitigate their exposure to any one single tax and the impacts of any changes being introduced.

 

We are actively monitoring this space and will be able to provide advice as we are clearer.  What is clear is the need for good quality independent financial advice.

 

We are specialist Independent Financial Advisers (IFAs), so we are able to advise on all areas of financial planning suitable for you, and due to our independence, we can recommend the best products and providers in the marketplace.

 

For further help or advice specific to your circumstances, contact me at Golden Oak Wealth Management on 01780 723118.

 

Meet Daniel Payne, Chartered Financial Planner at Golden Oak Wealth Management. Dan works closely with Cottons to offer expert regulated financial advice, bringing valuable insights for our clients. While we’re great at chartered accountancy and business advice, it’s important to know that financial planning has its own set of rules overseen by the FCA in the UK. As your accountants, we’re here to help navigate you to experts like Daniel for thorough financial planning. Understanding this difference is key, and we’re all about making things clear rather than putting up barriers.

This article is a joint effort to keep you well-informed. If you need any assistance, feel free to reach out to us or directly to Daniel.

daniel@goldenoakwealth.co.uk

07585 233528

01780 723118