The government’s announcement to include pensions in estates for Inheritance Tax from April 2027 will likely bring to an end the current opportunity to use pensions as a wealth transfer vehicle to children and grandchildren.
For some, there could also be a potential double taxation charge on death to navigate, with an effective tax rate as high as 67%.
This change in legislation, and the potential changes to the use and future role of your pension, is a great example of just how important financial planning is. So, as part of Financial Planning Week, we are launching our new series of articles, Unpacking Pensions: April 2027 and beyond.
In the run up to April 2027 we’ll be examining in greater depth the changes, sharing our thinking and exploring the planning options potentially available to you.
Below, we’re starting the series with an overview of the proposed changes and our current high level thinking on what this could mean for our clients.
A BRIEF PENSION HISTORY LESSON
Prior to April 2015, the pensions tax legislation levied a tax charge on death at 55% on lump sums paid from pensions after 75 years of age (and before age 75, from crystallised pensions in drawdown). The tax charge was viewed as a clawback of the Income Tax relief given on pension contributions and the tax free growth of pension funds.
The 55% tax charge on death was abolished from April 2015 to allow more flexibility in planning how pension funds could be used during retirement. As is now well known, it also provided the option of passing unspent pensions to future generations, who at worst might then only pay Income Tax at marginal rates on the funds withdrawn.
Pensions, overnight, became super tax efficient.
Post-Covid, the UK in common with many other countries, has a large debt burden which needs to be reduced to help stimulate future economic growth and provide government fire power against a future event adversely impacting the UK economy. Tax rises have already happened, under both colours of government, and the change to pensions from April 2027 is part of the latest round.
WHAT GOES AROUND…
So, from April 2027, we’ll pretty much find ourselves back to the pension tax landscape that used to exist prior to April 2015.
HMRC want pensions to be used for retirement provision only and, the new legislation will mean that pensions will, once again, be largely tax neutral. You get Income Tax relief on the way in on your contributions, tax-free growth and, apart from the tax-free lump sum, you are taxed on the way out when you draw an income.
As pensions become part of your estate, with a charge to Inheritance Tax (IHT), it’ll make sense to accumulate a sufficient amount in your pension fund to provide the base level of income needed to meet your day to day lifestyle costs during retirement, but ideally leaving nothing in the pension on your death bed.
Other savings accounts, such as ISAs and General Investment Accounts, whilst not providing the upfront tax relief will provide greater flexibility to drawdown funds to spend or gift in retirement. Accumulating greater amounts in a pension, and leaving them unspent on death, may not now be the best approach due to the possible double tax charge on both the pension and the beneficiary.
SO, WHAT WILL THIS MEAN FOR ME?
Currently, HMRC are consulting on the implementation of the pension changes. They anticipate significant changes will be needed by pension scheme administrators, who will need to account for and pay the IHT on unspent pensions to HMRC.
The consultation process will take a few more months yet before we see draft legislation published. And as the changes don’t take effect until April 2027, the current rules still apply, meaning no decisions ‘in haste’ should be required.
In the meantime, a helpful way to characterise the likely impact of the changes is to think about this in terms of your stage of life:
- If you’re below 55 years, the current minimum age to draw pension benefits, or still working, you likely need to make no changes and should continue saving into pensions as part of your retirement provision. Pensions will still play a central part. If you feel you’ve already accumulated enough in pensions, it’ll make sense to consider other savings vehicles, ISAs being the obvious first choice if not already being used.
- If you’re at the point of retiring, recently retired or in your 60’s to early 70’s, you’ll probably have time on your side to consider your options and how to use your pension fund effectively under the new legislation as part of your retirement plans. For some, it may even be appropriate to do nothing. You can let your pension funds continue to grow tax free for now and take appropriate action a few years down the line.
- If you’re well into your 70’s or older, the need to start planning will be more pressing. Whilst nothing necessarily needs to happen before 2027, discussing and exploring the planning options will be a good use of time. These will be specific to individual circumstances and could include drawing down on funds to spend and/or gift. It’s also again possible that for some, perhaps nothing needs to change. An unused pension fund may incur a charge to IHT post April 2027 at 40%, but whether the beneficiaries incur additional Income Tax, and at what rate, depends on their circumstances and what their need for the funds might be.
OTHER CONSIDERATIONS
We expect there’ll be a number of other knock-on planning issues to consider. For instance:
- Updating pension nominations may be needed as there’ll be a spousal exemption from the IHT charge on first death.
- Consolidating pensions will also be sensible to make sure paying IHT on unspent pensions is as easy as possible instead of being spread across a number of different providers.
The intended scope of the IHT charge on pension funds is yet to be fully understood on lump sum benefits paid (including those under pension and annuity guarantees), and even some death-in-service arrangements. As this and other aspects become clearer, there will no doubt be additional planning issues to consider.
From April 2027, pension funds will be added to the values of homes and other assets and so considerably more people will be pulled into a charge to IHT.
For others, their IHT exposure will increase, due to a reduction in their entitlement to the residential nil rate band of £175k (£350k for a married couple or civil partnership), which gets phased out for estates over £2m.
There’ll be much to consider and there may be more changes ahead, both on pensions and other areas, which could impact planning options, such as the Inheritance Tax gifting rules. Over the course of this year and next, we’ll explore all of these issues in our series, Unpacking Pensions: April 2027 and beyond.
In the meantime, if you would like to discuss any of the above matters, please do get in touch via theteam@cooperparry.com. Or, if you are already a client, please reach out to your Relationship Manager.
