Time to review your pension strategy ahead of inheritance tax changes

We are all reeling from the October Budget announcement that pensions will be part of our estate for inheritance tax, but what will it mean to the way you spend, or don’t spend, your pension funds in the future?

Steven Clemence, Chartered Financial Planner at Westcott’s Financial Management and a Fellow of The Personal Finance Society, gives us some food for thought.

What’s changed?

From April 2027, death benefits of our pensions will be included in our estates for inheritance tax purposes. For some this will mean a tax charge of 40% when leaving our pensions to the next generation.

For the last decade (since 2015, prior to which there was a 55% tax charge) those dying and passing on their pensions have been able to do so with their children receiving the money free from inheritance tax. Because of this a lot of people, in retirement, have been preserving their pensions and spending everything else first.

Why should I save into a pension?

We get tax breaks to incentivise us to save for our retirement; tax relief on contributions and virtually tax free growth on our funds while they are invested. The payback has been we are taxed through PAYE when we draw the income.

Most can take 25% of the fund out as a tax-free lump sum before drawing the taxable part. In the past most would then buy a guaranteed income for life, an annuity, and the Government would get its tax on the income. Annuities remain a good way of making sure your income will last as long as you do, but more people are now choosing to drawdown their pension, either to delay buying an annuity until they are better value, or to allow the flexibility to draw what is needed when it is needed.

Going back to what pensions are designed for

Pensions are designed to accumulate wealth while we are working so we can decumulate the wealth in retirement.

For most in the accumulating phase of their lives, saving into a pension remains a good strategy. They are good news generally – you save now and spend later, taking advantage of the tax breaks.

If you have been preserving your pensions to pass the wealth to your children then you may need to rethink. You might start drawing your pension, figuring that living off your pensions might allow other assets to be given to your children while you are alive – although most children I meet want their parents to be safe in their retirement rather pass on money they might need.

Or the extra income may allow you to take out life assurance that will payout to your children when a potential inheritance tax liability becomes due.

Of course, whatever plans you may settle upon are subject to the ever-present uncertainty that legislation can change again. It’s not that long ago the Conservative Government was talking about abolishing inheritance tax completely.

40% discount

I am not encouraging you to spend money you may need later, but I do meet a lot of people who don’t have the new kitchen or pay for the holidays they would like to have when they can afford to spend the money.

Food for thought; if you save it until you die it could be taxed at 40% – if you spend it, you are effectively getting a 40% discount!

Is this a time to panic?

With money, it is never a good idea to panic. There is time to plan, but plans going forward may be different to the plans you had.

This type of planning can seem complex, but what you will want is your financial planner, your accountant and your solicitor all working together to make sure you are doing the right things for you and your family. This takes time, but gives piece of mind.

The good news is that Westcotts are here to help you. Please contact Steven Clemence at steven.clemence@westcotts.uk or call 01752 666601.