Rachel Reeves announced proposals in the budget to bring "unspent" pensions into a person's estate for inheritance tax. To understand this, let's first explain the current rules, how this desired change is being managed, and our thoughts on what you might expect to see change as a result.
Currently, the UK's rules regarding pensions upon death allow individuals to pass on their pension pots to beneficiaries without incurring inheritance tax. If the pension holder dies before age seventy-five, the beneficiaries can inherit the pension tax-free. If the holder dies after seventy-five, the beneficiaries will pay income tax on withdrawals at their marginal rate. These rules encourage individuals to save for retirement while ensuring their loved ones benefit from their savings. The rules have made pensions attractive for intergenerational wealth transfer by providing tax-free growth and being outside the estate for inheritance tax.
The changes are planned to take effect from 6 April 2027. Therefore, the status quo applies to this date.
The actual changes are up for consultation, and you can read more about the process by viewing the government website. The consultation will run for 12 weeks between 30 October 2024 and 22 January 2025.
Once this consultation is completed, we will learn more about the rule changes.
Issues that will need to be decided are:
- What is the definition of an "unspent" pension?
- Will age still affect the rules? i.e., the current change in tax rules for inherited pensions at age 75.
- Will there be protections for existing pension holders? Historical changes have offered some enhancements for existing pension holders.
We generally advise families and individuals whose estates will be subject to inheritance tax to spend their cash first and leave pensions to grow tax-free, as they will pass to their families free from inheritance tax.
If pensions are brought into the estate for tax, we have some initial thoughts but await final notification of the rules. Everyone's financial plan will be different and specific to their family setup.
Our initial thoughts are...
1—If the pension is left to the survivor on a couple's first death, it should qualify for spousal exemption under inheritance tax. This will increase the need to seek good advice at this point. The survivor may want to consider draining the pension, switching to more inheritance tax-friendly investments, or gifting to start the seven-year clock on a potentially exempt transfer. Care must be taken to remove cash tax efficiently within the new rule framework.
2—The order of accessing cash for retirement expenditures may generally change. Cash may be used to invest in inheritance tax-friendly investments, and the pension may start to be the primary source of income to meet retirement expenditures.
3—It's possible to see an increase in equity release, which takes money from property to shift into inheritance tax-friendly investments as pensions increase the overall value of the taxable estate.
If the only reason you fund a pension is inheritance tax planning, seek advice as you may wish to pause funding.
Continue to save into pensions if you're seeking a tax-efficient way of building funds to provide income in your retirement.
Sit tight until the final changes are announced on 22 January 2025, and then meet with your financial adviser to discuss your next steps. We welcome your call if this area concerns you!
Our services relate to certain investments whose prices depend on fluctuations in the financial markets beyond our control. Investments and their income may go down and up, and you may get back less than the amount invested. Past performance is not a guide to future performance.
Taking an equity release loan could affect any benefits you may be entitled to, your taxation, and the value of your estate.