Nick Rudd
In her Autumn Budget back in October 2024, Chancellor Rachel Reeves announced changes to the Inheritance Tax (IHT) treatment of pensions. The proposal to move pensions into the IHT net could have the greatest impact on high net worth individuals (HNWI).
Keep reading to find out what the proposed changes are and how they could affect your retirement and estate planning.
As a HNWI, your pension fund might form a key part of your current estate planning
Your pension is designed to provide you with an income when you finish work and most people intend to use theirs for exactly this purpose. For this group, the chancellor’s changes won’t have much effect on their long-term plans.
As a HNWI, though, the story might be a little different.
If you have high-value investments and income from other sources, such as a property portfolio, you might not be reliant on your pension income when you finish work. It might still make sense to contribute to a pension – the government incentivises pension saving through tax relief, after all.
Therefore, you might have accrued your pension pot specifically to leave a tax-efficient inheritance.
This pot now represents a potential IHT liability.
Advice might help you to take a holistic and objective look at your wealth
The first important point to remember is that pensions are tax-efficient. We’ve already touched on tax relief but as a further reminder, contributions automatically receive relief at 20%. You can then claim an extra 20% or 25% as a higher- or additional-rate taxpayer, respectively.
Funds inside a pension grow tax free and when you come to take your pension, you’ll usually be entitled to 25% of your fund tax-free, too. The long-term benefits of this are significant.
Only ISAs are on a similarly tax-efficient footing, but the ISA Allowance stands at just £20,000 a year, severely limiting the amount you can invest and save.
As such, you’ll need to look holistically at your wealth and think about the best IHT mitigation strategy for you.
This is where professional advice can help.
There are several simple steps you can take now
Currently, the changes are only a proposal and the final legislation has yet to be drawn up.
In addition, the proposed changes don’t take effect until 2027 and there has been a Consultation on some of the practical elements. Because of this, there is still some detail that has yet to be confirmed. Therefore, making a knee-jerk decision now could lock you into a sub-optimal choice with long-lasting ramifications for your pension.
We’ve recently written about how to manage complex life insurance and estate planning as a HNWI and some of the strategies mentioned might be useful here.
If your pension wealth is set to leave you with an IHT liability, your first step could be to insure that liability. Next, consider ways to lower the value of your estate, through tax-efficient gifting and making use of HMRC allowances.
While bringing pensions into the IHT net puts them in the same boat as the other products you hold, remember that your pension wealth still sits within a tax wrapper and, under the new rules, will only become taxable when you die.
You might, though, be able to gift pension wealth tax-efficiently. Just as with other assets, gifts to your Spouse are exempt from IHT and pensions will be no different.
An often overlooked HMRC gifting exemption could become a powerful IHT mitigation tool
You can make as many gifts as you like during your lifetime. These gifts are known as “potentially exempt transfers (PETs)” because they’re only IHT-exempt if you survive for seven years after the date the gift is made – the so-called “7-year rule”.
Some HMRC exemptions allow you to make gifts that are IHT-free from the moment they are made.
One of these is the “normal expenditure out of income” exemption, which is often overlooked. In fact, a Freedom of Information request by the Telegraph found that during the 2022/23 tax year, just 430 people made use of it. Changes to pension IHT rules might see that trend change.
The normal expenditure out of income exemption can be used to make regular IHT-free gifts, as long as you can prove that the gift:
- Is made out of your usual income
- Comprises part of your normal outgoings
- Doesn’t detrimentally affect your standard of living.
You may need to prove your gift meets these criteria, so thorough record-keeping is a must (this might also account for why the exemption is so often ignored). But speaking to a professional can help to ensure your records are complete.
You can use this exemption to make regular gifts from your pension, lowering the value of your estate for IHT purposes while helping loved ones. For example, you might use the gifts to make regular payments into a child’s pension or ISA.
When Rachel Reeves spoke about the change, she referred to it as an IHT “loophole” but, with the right guidance, it could provide a different set of opportunities to provide your loved ones with a living inheritance.
Sadly, there isn’t a “silver bullet” that will simply mitigate this change to pensions. In reality, for most, the best strategy will be to re-look at your IHT liability now and how that will change from 2027 and then work through each of the potential strategies to mitigate IHT; to find the right combination of planning for your specific circumstances.
Get in touch
To find out how we can help you manage a potential IHT liability from the pensions you hold, please get in touch.
Contact us online or call 020 7400 4700.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
