The Budget on 30 October 2024 was a watershed for pensions and Inheritance Tax (IHT) planning.
Changes announced by the chancellor, Rachel Reeves, that will come into effect from April 2027 mean that pensions are set to be included in the value of your estate for IHT purposes. As a result, any accrued pension fund you have could become liable not only for IHT, but also Income Tax payable by the beneficiary after you pass away.
Read more: Could your beneficiaries be facing a 90% tax on their inheritance? Here is what you need to know
Up until now, accruing assets in a pension fund has been a potentially advantageous way to pass a substantial sum to your beneficiaries free from IHT, as well as providing an income for you in retirement.
Clearly, in response to these changes, you may need to review your retirement and estate plans. Indeed, such a review could be highly beneficial from a tax mitigation perspective.
Find out why that may be the case in this article, and read some pension withdrawal strategies you may want to consider.
You may want to review your current retirement income plans
As part of your review of your pension and estate planning arrangements, it may be important to assess how much of your retirement fund you will want to use to provide you with an income after you stop working.
It is important to bear in mind that securing your own future financial security should be your first priority. So, you will likely want to ensure that you put the necessary arrangements in place to fulfil this before considering the effect any changes to IHT could have on your beneficiaries.
Beyond this, you may well want to pass a substantial proportion of your pension fund to your beneficiaries. In this case, it could make sound financial sense to do this while you are still alive.
By doing so, you can increase the chance that those assets will not form part of your estate for IHT purposes, rather than those assets being potentially subject to IHT on your death.
Clearly, what you do will depend on your personal circumstances, but there are some simple steps you could take to mitigate the potential for your beneficiaries to face an IHT liability on your pension fund when they inherit from you.
Annuities provide a regular income and the value is removed from your estate
One option you could consider is looking at the value of annuities.
An annuity will provide you with a regular income for the rest of your life in return for a lump sum from your pension fund. The amount of income you will receive will depend on your age, and the annuity rates applicable at the time you purchase.
According to This is Money, annuity rates are currently at their highest figure for a decade. This resulted in over £7 billion of pension assets being used to buy an annuity in 2024, up 34% from 2023.
The changes could make annuity purchases an even more attractive option. This is because:
- The amount you use to purchase an annuity will no longer form part of your estate (although the income might if you choose to hold it in savings as and when you receive it). This is unless capital protection is included to pay out on death the difference between purchase price and annuity payments already received.
- It will provide you with a guaranteed income that can increase by a fixed amount each year.
- You can set up an annuity on a joint-life basis so that income will continue to be paid to your spouse or partner until they die if you predecease them. Bear in mind that an annuity paid to a dependant or nominee would be included for IHT purposes, and it is not yet clear on annuity guarantee payments.
Remember, you do not have to use your whole fund to purchase an annuity, and you can have more than one in place. This means that you could use annuity purchases tactically to remove funds from your estate, while still providing yourself with regular income.
Gifts out of surplus income will not be liable for Inheritance Tax
Another strategy you may want to consider is making gifts out of surplus income directly to your chosen beneficiaries.
Income from your pension fund will still be subject to IHT if it remains unspent as part of your estate, such as in a bank account.
But, you can make gifts to your loved ones directly from income, including that drawn from your pension fund, and these sums can fall outside of your estate for IHT purposes.
As long as the gifts are made directly from your income on a regular basis, and do not affect your standard of living, they will fall immediately outside of your estate.
This enables you to pass wealth to your intended beneficiaries to be earmarked for specific purposes, such as school fees for your grandchildren, or to fund a tax-efficient Junior ISA.
You could consider gifting your tax-free lump sum
You could also think about gifting your 25% tax-free pension lump sum to your beneficiaries when you come to access your fund from age 55 (rising to 57 in 2028).
Your pension income is potentially subject to Income Tax at your marginal rate, with the exception of your 25% tax-free cash allowance (up to the Lump Sum Allowance of £268,275 in 2024/25).
As a result, it could be advantageous to remove your tax-free amount from your fund and gift it to your intended beneficiaries. However, you will need to consider whether doing this will affect your ability to meet your own financial goals, which should always be a priority when it comes to your financial planning arrangements.
While some providers take the view that using tax-free amounts that are withdrawn on a regular basis might count as a gift from surplus income, HMRC may treat these gifts as a “potentially exempt transfer”. This means that the value would only fall outside of your estate for IHT purposes after seven years.
Bear in mind that the gift may be subject to IHT if you die within seven years.
Your pension assets will pass to your spouse or partner free from IHT
As well as the planning opportunities you have read about here, it is also important to be aware that your spouse or civil partner will inherit your pension free from IHT.
This will give them the opportunity to further remove pension assets from the value of your combined estate prior to their death, in addition to any mitigation arrangements you may have made.
Professional advice is essential
The changes announced are likely to impact your retirement and estate planning from April 2027. So, it is worth thinking ahead about what they might mean for you, and what you can do to prepare.
We can support you with this at DBL Asset Management. We will help you understand how the changes could affect you, and the steps you could consider taking to minimise the amount of IHT liable on your estate. We will also help you assess how any potential steps could affect your own long-term financial security.
If you would like some guidance around your own pension and estate planning, then please do get in touch with us today.
Email enquiries@dbl-am.com or call 01625 529 499 to speak to us.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients 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.
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.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
The Financial Conduct Authority does not regulate estate planning or tax planning.