It is the biggest rethink on pensions since 2015 — and it will lead many carefully laid financial plans to be painstakingly unpicked.
The importance of pensions as a means of inheritance tax (IHT) planning — to be held for as long as possible so they can be passed down — has been turned upside down by reforms announced in last week’s Budget. From April 6 2027 most unused pension funds and death benefits will be included within the value of a person’s estate for IHT purposes.
This could reduce how much of your pension goes to your partner and what you can leave to your children after you die.
Many advisers are busy working out how best to switch their clients’ pensions back to their original intended use — providing retirement income. This might involve reconsidering taking drawdown or annuities earlier than originally planned.
Could it be too late for retirees to switch their plans around? Many in mid-retirement have already spent investments such as individual savings accounts (Isas) and savings — to fund their early retirement.
Others have transferred a defined benefit pension into a defined contribution scheme to pass on money tax efficiently to loved ones. Some have made larger contributions into their defined contribution pension to make the most of the existing rules.
You may feel cheated, but if you’re lucky enough to be in possession of a large pension, there’s no reason to panic. In fact, the scale of the problem could be overstated.
Today, under IHT rules, a person can pass on up to £1mn with no IHT to pay, as long as they have received a nil-rate band of £325,000 from a spouse and the estate includes a primary residence. Only 4 per cent of estates pay IHT — charged at 40 per cent on any surplus assets.
By bringing pensions into the loop, the government estimates that an extra 1.5 per cent of total UK deaths will become liable to pay IHT. That’s 10,500 out of around 213,000 estates with inheritable pension wealth in 2027 to 2028.
Further to this, 38,500 estates will pay an average £34,000 in additional IHT because pension assets are included in the value of the estate.
But these are the revenues that HMRC says could be raised based on current financial planning behaviour. And those 49,000 estates have several tools at hand to reduce down the IHT bill. William Burrows at financial adviser Eadon & Co says: “It should be perfectly possible for people in their 60s and 70s to rethink their pension strategies.”
First, if you’re not married, perhaps the most important thing you can do is propose. Doug Brodie, managing director at retirement income advisers Chancery Lane, says: “Cohabitees who are retired and have money purchase pensions now face a 40 per cent tax bill on their individual pensions.
“So when one dies and leaves the pension to the other, the pension gets reduced to only 60 per cent of the prior sum. Whereas the married couple next door gets to pass on 100 per cent when one dies.”
Next, anyone who is married should check how their death benefit nomination form is set up, with many advisers recommending it’s best for IHT purposes to stipulate that the pension is paid 100 per cent to your spouse when you die, not partly left to your children, for example, where they may fall into the IHT net.
People with large pensions could simply spend more of them on the fun stuff — holidays and meals out. Or they could give more generous or frequent gifts during their lifetime to pass wealth to beneficiaries.
Gifting could either take place during an individual’s lifetime as an alternative to pension saving or, if the individual is able to access their existing pension funds, by drawing down the pension to gift to beneficiaries.
Alternatively, gifting to boost or start a loved one’s pension could be extremely tax efficient in addition to keeping your own estate below IHT thresholds. Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, says: “Pension recycling rules don’t apply if you contribute to the pension of another person, so it could make sense to top up your partner’s pension or a child’s Junior Sipp to boost their own retirement planning.”
You can contribute up to £2,880 a year into a non-earner’s pension and still receive tax relief, which will top it up to £3,600.
But the key message from wealth advisers is not to make any hasty moves beyond what you might have been inclined to do anyway. Given that transfers between spouses are still exempt from IHT, for many people the IHT “problem” could be 20-30 years away.
Also, what you worry about in early retirement may not be the same as when you reach 80. Burrows says: “Many people underestimate their life expectancy, especially when they first retire. This means many people put the objective of leaving an inheritance higher than ensuring they don’t run out of income.”
In your hierarchy of needs, as you get older that income may eclipse leaving a legacy. And by then there may be different rules in any case.
Some point to the chancellor’s plans to bring pensions into IHT as being poorly thought through and facing “substantial challenges”. Could Rachel Reeves backtrack if the economy sees signs of growth in the interim? Some experts think there may be a positive effect on income tax revenues before 2027 if people currently following a “spend the pension last” approach change course. A U-turn in two years could be a potential vote winner.
Plus, there’s a complex HM Revenue & Customs’ technical consultation under way, which introduces a certain amount of cynicism. The key problem this addresses is that the change incorporates a major headache for pension schemes.
HMRC’s plan is that pension scheme administrators will become liable for reporting and paying any IHT due on pensions to HMRC. Until now, that’s been done by the personal representative of the deceased’s estate.
It’s possible that there could be a huge outcry from pension schemes around the processes involved — some highlight an “unrealistically compressed” proposed timeline for reporting IHT liabilities and the potential for increased costs, inevitably passed on to consumers. This could lead to delays in implementation.
Other experts say it would be a hugely messy process — perhaps impossible — to calculate and process one person’s IHT liability from multiple schemes. A solution is for individuals to consolidate their pensions into one scheme. But how would that be enforced?
Instead, the plans will require the swift implementation of pension dashboards. This new online government tool will allow savers to see all their pensions — state, workplace and personal, in one place.
The plan for pension dashboards was launched in 2016, but the project has suffered a range of delivery problems and increased costs. Onboarding of pension schemes and providers is expected from April 2025. But if that doesn’t happen, expect delays to IHT on pensions too.
Moira O’Neill is a freelance money and investment writer. Email: moira.o’neill@ft.com, X: @MoiraONeill, Instagram @MoiraOnMoney
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