In her 2024 Budget, Rachel Reeves announced a crucial change to the tax treatment of pensions when you pass away.
Currently, when the executor of your will adds up the total value of your estate to calculate whether any Inheritance Tax (IHT) is due, your pensions aren’t included.
This means you can pass any remaining wealth in your pensions to your beneficiaries without tax. As such, although the recipient may pay some Income Tax when drawing from the pot (depending on your age when you pass away), your pension is an excellent tax-efficient estate planning tool.
Unfortunately, this exemption will end on 6 April 2027, and pensions will be considered part of your estate from this date onwards.
Figures from Standard Life estimate that, in 2027/28, 49,000 estates will pay IHT for the first time or face a higher bill because of this change.
Research shows that 22% of people have less confidence in pensions after Inheritance Tax changes
Your pension is likely to be a central pillar of your retirement saving strategy, as well as your estate plan.
However, the planned changes have affected attitudes towards saving strategies, as Standard Life reports that 22% of people were less confident about their pensions because of the new rules.
Among those who felt less confident:
- 54% were worried their beneficiaries would pay more IHT
- 38% were unsure about the tax implications of the change.
You might be feeling similarly apprehensive about what these changes mean for you and may even wonder if you should focus on contributing to other savings and investments instead of prioritising your pension.
Fortunately, if you consider your estate plan now, you can mitigate the effects of this change and pass as much of your wealth to loved ones as possible.
Here are three important questions to ask as you prepare for new rules about IHT and pensions.
1. How will I be affected?
It’s easy to assume that new IHT rules will significantly reduce the amount of wealth you can pass to your loved ones.
This is true for some, but it’s worth noting that Standard Life figures suggest only 7% of estates will be affected in the first year of the change.
While yours might be one of those estates, the increase in IHT may not be as significant as you fear. You also have options for mitigating a large tax bill.
Before you panic and make any reactive decisions, it’s important to be clear about exactly how you will be affected.
We can help you understand your position by reviewing your estate and considering how much of your wealth you might spend each year in retirement.
Using cashflow forecasts that account for factors such as inflation, house price rises, and investment growth, we can estimate how much wealth you may leave to your loved ones. Therefore, we can consider how much IHT your family might pay.
Consequently, you can plan from a place of knowledge rather than speculation.
2. Do I need to adjust my retirement income strategy?
While pensions are exempt from IHT, it might make sense to use savings from other sources, such as ISAs or General Investment Accounts (GIAs), to generate much of your retirement income.
This is because you can retain the wealth in your pension and pass this on without IHT. Meanwhile, ISAs, savings accounts, and GIAs will attract IHT, so you may prefer to spend this wealth first.
Another potential benefit is that you won’t pay Income Tax when drawing from an ISA but will when accessing your pensions (after using your 25% tax-free lump sum).
However, once pensions are no longer exempt from IHT, you may want to review your strategy.
As retaining pension funds will be less important than it once was, you may decide to spend more of this wealth to potentially mitigate a large IHT bill later.
We can discuss options for a retirement income strategy, drawing from your various sources of savings in the most tax-efficient way possible.
3. Could I gift more wealth to my loved ones now?
One of the most effective ways to mitigate IHT is to gift wealth to your loved ones now and reduce the size of your taxable estate.
Each year, you can gift £3,000, which automatically falls outside your estate. This is an individual allowance, so a couple can give £6,000 between them.
There is also an annual allowance if gifting money for a wedding, which lets you pass on:
- £5,000 to a child
- £2,500 to a grandchild
- £1,000 to anybody else.
Beyond this, there are specific rules for small or regular gifts that may allow you to transfer even more of your estate.
Any gifts that aren’t covered by a specific allowance or exemption are known as potentially exempt transfers (PETs) and may still be IHT-free provided you live for seven years after giving the gift.
It’s worth considering whether you could gift more wealth to your loved ones now, potentially drawing a higher amount from your pension and passing it on, to reduce IHT later.
We can help you plan this, so you make effective use of the available allowances, while also ensuring you have enough income to maintain a good standard of living in retirement.
Get in touch
Upcoming changes to IHT and pensions may be daunting, but with our support, you can prepare effectively.
Please get in touch to find out how our team of VouchedFor Top Rated planners could help today.
Please note
This article is for general information only and does not constitute advice. The information is aimed at individuals only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, cashflow planning or tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.