Possibly, but there's no need to rush-yet.
A Quick Overview of the Challenges
Pensions have long been valued not only as retirement savings tools but also for their tax-efficient benefits, particularly in the context of inheritance tax (IHT) planning. However, recent changes announced in the budget may alter how pensions are used in estate planning.
One of the most notable changes concerns pension death benefits. From April 6, 2027, the value of pension funds immediately before death will be included in an individual's estate for IHT purposes. Previously, pensions enjoyed an exemption from IHT, providing an opportunity for transferring wealth across generations.
Under the new rules:
- If the estate exceeds the IHT nil-rate band, IHT will apply to the pension value.
- The IHT liability will be deducted by the pension scheme administrator before the funds are distributed to beneficiaries.
This change could significantly impact high-value estates, as it introduces additional complexity and costs to inheritance planning.
Further compounding the issue is the potential for double taxation in certain circumstances. Pension Scheme Administrators may also need to deduct Income Tax at the beneficiary's marginal rate when payments are made. The total tax burden will depend on how the beneficiary chooses to access the funds and their personal income tax situation. For beneficiaries in higher tax brackets, this could mean substantial deductions, diminishing the financial legacy left by the pension holder.
What Hasn't Changed?
Despite these challenges, many of the original benefits of pension savings remain intact:
- Tax-Free Lump Sum: The tax-free lump sum allowance remains unchanged. Most individuals can withdraw 25% of their pension savings tax-free, up to a standard lifetime allowance of £268,275. This is still a significant advantage for those planning their retirement income.
- Contributions and Tax Relief: Pension contribution rules remain the same for now. You can continue making contributions and receiving tax relief at your highest marginal rate. For many, this remains a tax-efficient way to manage income during their working years while deferring taxes until retirement-potentially at a lower rate.
These unchanged benefits highlight that pensions still play a crucial role in retirement planning and can offer flexibility and tax efficiency.
Will This Change Behavior?
Almost certainly.
Most individuals already use pensions primarily to fund their retirement, either by drawing an income or making capital withdrawals. However, for those who do not anticipate needing all their pension funds, the impending changes are likely to prompt adjustments in behavior:
- Increased Lifetime Withdrawals: Many people may choose to withdraw more from their pensions during their lifetimes. This could be to spend more, given the prospect of IHT charges, or to make financial gifts during their lifetime.
- Reconsideration of Income Options: Some individuals may prefer guaranteed income streams, such as annuities, over leaving pension funds to beneficiaries.
Ultimately, the decisions will vary widely depending on personal circumstances, financial goals, and the potential impact of these changes.
What Should You Do?
With the new rules set to take effect from April 6, 2027, there is time to adapt. Moreover, the complexity of these changes and the potential for double taxation-particularly for deaths after age 75-could lead to revisions during the consultation period, which concludes in 2025. While this offers a glimmer of hope, it's wise to prepare for the changes as they stand.
Here are some steps to consider:
- Consult with Your Advisers: Schedule a meeting with your tax adviser and financial planner to assess the potential impact on your estate and retirement strategy. Early planning will help identify the most effective ways to mitigate any negative effects.
- Evaluate Your Savings Goals: If your primary goal remains retirement income, pensions remain a valuable savings vehicle. However, if your pension is part of a broader estate planning strategy, it may be time to revisit your approach.
- Review Death Benefit Nominations: Ensure your pension death benefit nominations are up to date. Passing your pension to a surviving spouse or civil partner may allow for better estate management and reduce IHT exposure for the next generation.
- Consider Taking Tax-Free Lump Sums: If you've deferred taking the tax-free portion of your pension beyond age 75, reconsider this strategy. Accessing the lump sum earlier could help avoid the risk of both IHT and Income Tax deductions.
- Plan Lifetime Gifts: With the possibility of pensions being taxed more heavily upon death, withdrawing funds during your lifetime to make gifts could be an attractive alternative. Lifetime gifts can help reduce the value of your estate while benefiting your loved ones sooner.
- Reassess Other Assets: If you plan to draw more from your pension, consider how this might impact other assets in your estate. You may need to rebalance your portfolio or adjust your gifting strategy to maintain tax efficiency.
