William Burrows heads The Annuity Project and is a financial advisor to Eadon & Co.
There is no doubt that Rachel Reeves’ announcement that from April 2027 unused pension funds will be subject to inheritance tax is bad news, but is it as bad as many people say?
Recent headlines on this topic, such as that Reeves’ inheritance tax raid puts millions of people at risk of poverty in old age or that inherited pensions could suffer a “double tax hit” of up to 70.5 percent cent, paint a gloomy picture and cast a dark shadow over pensions.
But I don’t think we should be so despondent or worried: it shouldn’t negatively affect most pension plans and, when it does, there are some simple things that can be done to reduce the impact.
To be clear; Those with very high pensions will probably end up having their unused pension funds subject to inheritance tax, but even those with above-average funds should be able to avoid this.
Why do I think this topic is overcooked? There are three reasons:
– The new rules should only affect those with very high pensions.
– More people will benefit from receiving income from their pensions
– There are simple and legitimate ways to mitigate inheritance tax.
Budget raid: Government plans to make pensions subject to inheritance tax like other assets such as property, savings and investments
One of the problems with pensions is that people have a different perception of capital compared to income.
A million pound pension seems like a lot of money, while £40,000 a year seems like less money.
But in terms of pensions they are the same because with 1 million pounds you buy an inflation-linked pension of 40,000 pounds per year for a couple aged 65 and 60.
If you don’t want to secure a guaranteed pension, you can invest in a pension drawdown and earn the same amount of income and, under standard assumptions, this will last until your normal life expectancy, but there are risks involved.
If the investment returns are lower than expected, you risk running out of money before you die, but if the returns are higher, you will have money left over to leave to your family.
According to the Pensions and Life Savings Association, a married couple needs a retirement income of £59,000 a year to enjoy a comfortable retirement – and that’s after tax and doesn’t include housing costs or care costs.
The thing is, most people will need to use some or all of their personal or company pensions in addition to their state pension to earn this amount of income.
Of course they can use their Isa, savings and investments instead of their pension, but how many people have enough personal wealth to generate this amount of income without touching their pension?
Don’t forget that it’s wise to maintain a decent fund with emergency savings so that not all savings need to be used to generate income.
Income from Isa savings does not attract income tax, while pension income does, so it is important that people receive advice on the most tax-efficient way to organize income during the retirement.
All of this means that although many people think they will leave their pension to their children, they can actually use the majority of their pension to provide income for themselves and their spouse/partner.
If the pension holder dies first, their pension fund can pass to their spouse or common-law partner without having to pay inheritance tax and, in the event of their death, there will be an inheritance grant of £1 million to use if They leave their home to their direct descendants.
You can also reduce the value of your pension by gifting money, after paying income tax, to beneficiaries before you die.
Regular gifts of excess income can be immediately free of inheritance tax; Otherwise, you must live more than seven years to avoid inheritance tax.
It is still early days in terms of planning changes to inheritance tax, but most commentators agree that more income from pensions will make sense and this will not be a bad thing.
The maths can be complex, but if people don’t earn income from their pension at the right time and in the right way, they could be ‘throwing money down the drain’.
Simply put, there is an opportunity cost to not receiving income from your pension. Let’s take a £100,000 pension fund and assume it could produce an income of £6,000 a year.
If income is delayed by one year, £6,000 will not be taken. Over five years £30,000 will be given up.
In many cases, although the income earned in the future may be higher, it will not be high enough to compensate for the income forgone.
This means that delaying earning income can result in lower income over a lifetime.
Annuities are misunderstood because they are not ‘legalized theft’ by insurance companies, but are the optimal way to maximize lifetime income without risk.
Therefore, if income is to be deducted from pensions, annuities should not be overlooked.
I can understand how charging inheritance tax on very large, unused pension funds will result in higher inheritance tax bills, but for most people, with good retirement income advice, they should be able to maximize their own lifetime income and maximize the amount. They live for their children after accounting for all taxes.
Finally, in my experience, expectations change with age, especially as people underestimate their life expectancy when they first retire.
Generally speaking, when people first retire they place a high priority on leaving an inheritance, but as they age they realize that they may need their pension funds to fund their own retirement, especially if they may need expensive care fees. .
Adult children also tend to be better off financially by then.
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