We spoke to Rebecca Bonner, Director & Independent Financial Adviser at Trigpoint Financial Planning, and asked her to share her expertise on pensions and tax in light of the planned government changes announced in the recent budget.
What sort of strategies would you employ, if someone expected to use their pension for the next generation, now there are plans to include them in inheritance tax calculations?
I think as financial planners we're going to have to completely rethink people's plans. In recent years we've very much had the pension as being the absolute last pot to touch. If you die before the age of 75 then it goes to your loved one's tax-free completely, if you pass away after the age of 75 it gets subject to income tax at the beneficiary's marginal rate, so it’s been an effective tax planning tool for generations.
I can see the reason they've brought them into inheritance tax calculations, they are a large proportion of people's wealth these days and I don't think it was ever really envisaged that they would become such a valuable tax wrapper, but the issue is that we still seem to have income tax as well. You potentially would have somebody being subject to inheritance tax if there was still £100,000 in the pension pot at death. Being subject to 40% inheritance tax leaves it at £60,000 and then if beneficiaries want to take that out, it being subject to income tax reduces it further.
"One of the key things to say is that it doesn't come in until April 2027 and there is a consultation over the next three months. We need to start having conversations about the way things will go, assuming it comes in."
If the changes do come in as announced, and there will be income tax and inheritance tax on the pension pot following death, then it completely makes sense to take your tax-free cash, because your tax-free cash element disappears on death. It would be subject to inheritance tax in your pension or outside your pension so there's no disadvantage to doing so, except the capital gains tax free growth during that period.
If you can afford to give it away and live seven years, then it would be outside of your estate, and you would not pay tax.
There is also an added complication of the loss of the residence nil rate band where the total estate exceeds £2 million. This means the effective tax rate can be really high.
I think the entire budget will really encourage people to start thinking about planning more and giving away. It's an unpalatable situation for some people. They like to hold on to everything, which is why we have inheritance tax.
"We encourage people to engage with our advice and work out how much is enough for them, what do they need, because we don't want people giving away too much, but if you've got a sound financial plan, then you can get the comfort that you will be okay. "
Will many people be affected by these changes?
There are debates to be had about the benefits and detriments of each type of pension. I think with these final defined contribution pension schemes, if you aren't in a position where you've got assets to gift away, you add your pension to your family home, a lot of people will be over the million pound limit. A lot of people could be brought into inheritance tax that wouldn't have been there before.
If we take normal couples, there was a long time when they really did not want to put into a pension. The previous governments have done a good job of encouraging them to save and one of the issues now is “What are the tax benefits of having it in a pension wrapper?” If you are putting significant parts of wealth into a wrapper, then the government can suddenly change the taxation and accessibility of it at a whim, it builds distrust. It was only recently that the Government changed the rules relating to the age people can access them. Tying significant sums up in pots that are a political hot potato is not going to be popular. Tax payers need certainty and pensions, it would seem, do not provide it.
They could become a lot less popular. For a government that's really concerned about how people are going to pay for their old age, it's an issue. It's an issue that I'm not entirely sure we will see the impacts of for a long time. We'll have to see what actually comes in. If people decide not to save for their own retirement and we end up with people relying on the state, the money’s just not there to bail them out.
Nothing in this article should be deemed to constitute the provision of financial, investment or other professional advice in any way.