Chancellor Rachel Reeves dropped a pension reform bombshell in Wednesday’s Budget so dramatic that experts say the golden rules of retirement income planning now need to be thrown out the window.
From April 2027, pensions will be drawn into the inheritance tax net for the first time. Thousands of Mail readers have voiced their feelings of betrayal.
For years, they have (very sensibly) been funnelling money into their pensions, safe in the knowledge that anything they didn’t spend in retirement could be passed down to their children free of inheritance tax.
Now families who have carefully planned their futures say the impact of the new rules will be ‘immense’ and ‘unfair’.
Many will now have to go back to the drawing board to rethink their retirement spending and protect as much from the taxman as they can as the new rules kick in.
Here are some of the strategies experts say families can use...
Give away pension cash during your lifetime
Until now, any financial adviser worth their salt would have told you to spend money from your savings accounts and Isas first in retirement and leave your pension until last. Any remaining funds in your pension could then be given tax-free to loved ones. But from April 2027, anything in your pension when you die will count as part of your estate.
This means preserving pensions is no longer such a tax-efficient strategy.
Shaun Moore, tax and financial planning expert at wealth management company Quilter, says: ‘Now, using your pension wealth for retirement is key. This means that any wealth outside of a pension now needs to be thought about in a different light.’
You can pass on assets worth up to £325,000 tax free – or £650,000 for a couple who are married or in a civil partnership. (There is an additional £175,000 per person allowance to cover a family home).
Growing numbers of families will find that once they add their pension wealth to the value of their properties and other assets, they exceed their allowance.
Everything above your allowance is subject to tax at a rate of 40 pc. If you intend to pass money on to loved ones – and expect that you have more than you will need during your own lifetime – you could consider withdrawing funds from your pension to gift to them.
If you survive for seven years after making the gift it is free from inheritance tax. If you die between three and six years of making the gift, inheritance tax may be payable but at a rate lower than 40 pc.
The 25 pc tax-free cash rule that allows you to withdraw a quarter of your pension tax free may be a useful way of withdrawing your money without facing a tax bill.
This allowance will become more valuable than ever, says Kate Smith, head of public affairs at pensions group Aegon.
‘People will look at drawing out money more quickly than previously because it won’t necessarily be in your interest to leave it where it is any more if you have saved a lot,’ she says.
However, withdrawing money from a pension is riddled with complexity and obstacles.
It can lead to limits on how much you can subsequently save, leave you with an unexpected tax bill and curb your ability to grow your wealth.
It is recommended to make sure you get expert advice or guidance before going ahead.
Spend it during your retirement
The easiest way to make sure your savings don’t fall into the taxman’s clutches is to spend it all during your retirement.
Ms Smith says: ‘I expect we will see a large number of people spending more of their pensions during their lifetime because there is less incentive to leave it in the pot now.’
From well-deserved holidays for the whole family to home renovations, pensioners will be more likely to treat themselves.
However, it is important to make sure you leave enough aside to see you through your later years.
Baroness Ros Altmann, a former pensions minister, warns: ‘Pensioners will be encouraged to spend their pension while still relatively young, leaving much less to live on if they survive to older age.’
Consider other tax shelters
For a long time, pensions have been the most tax-efficient investment you could make. You receive tax relief at your marginal rate on the way in, can draw 25 pc out tax-free from the age of 55 and there was no inheritance tax to pay on unused funds.
But now they fall into the inheritance tax net, Ms Smith says pensions will lose this status and be much the same as – if not less attractive than – other tax-efficient accounts, such as Isas.
She says: ‘They still retain some tax perks like tax relief on the way in. But if you die after age 75, any money left in your pension will be taxed twice – both by inheritance tax and income tax paid by the beneficiary of your estate.
‘This could make it less attractive than some other savings accounts, such as Isas where you do not pay income tax when withdrawing the money.’
You can save up to £20,000 a year into Isas without having to hand over a penny of tax on the interest, returns or capital gains earned.
Savers who withdraw money from their pensions may consider putting it into an Isa.
Marry your partner
All assets left to a spouse or civil partner are exempt from inheritance tax – and that will include pension pots. However, unmarried couples enjoy no such exemption. Therefore, if you have a large pension pot that you would like your partner to receive on your death and it would be liable to inheritance tax, marriage is one option to think about.
Ms Smith says: ‘This may be an easy way to protect money from inheritance tax.’
Bear in mind that there are also multiple other financial implications for marriage that need to be considered.
Consider taking out an annuity
Annuities, which pay a guaranteed income for life in exchange for an upfront lump sum, are likely to come back into vogue, according to experts.
William Burrows, founder of the Annuity Project, a website that provides information on annuities, says: ‘It is likely that pensions will be used less for passing wealth to the next generation and more for paying out an income during retirement.
‘If you take money out of your pension as and when you like, you run the risk of taking too little and paying inheritance tax on it, or taking too much and running out of money while you are still alive.
‘But with an annuity you know it’s going to keep paying until death and you won’t run out.’
Using £100,000 out of your pension at the age of 65 would buy you a guaranteed joint-life annuity income of £6,341 for the rest of your life.
The annuity would continue to pay out two-thirds of the income to your spouse upon your death, according to Mr Burrows. This is up from £3,900 during the lows of 2020.
You do not need to use your entire pension to buy an annuity. You can use a portion of your fund to guarantee a minimum income in retirement and use your remaining pension wealth as and when you need it.
Put your money into a trust
Trusts may become an increasingly attractive option for families who are concerned about inheritance tax.
You can leave an inheritance in a trust, some of which allow you to retain some access to the money you’ve given away, while minimising the tax liability. Mr Moore, of Quilter, says: ‘Trusts continue to be a very valuable tool. They offer a way to remove assets from the taxable estate, potentially reducing inheritance tax exposure.
‘Discretionary trusts, in particular, allow assets to be managed flexibly for the benefit of multiple generations while only incurring a periodic tax charge of a maximum of 6 pc.
‘This can be far more favourable compared to the 40 pc of inheritance tax that would otherwise be levied on inheritances.
‘However, it is worth noting that you may lose access to your wealth, so any strategy needs to be well thought out and leave the benefactor with enough funds to live on and/or pay for care needs.’
