Has the recent Budget changed your future lifestyle spending plans?
Rachel Reeves’ first Budget may prove to be the biggest game changer for pensions since the pensions freedom announced in 2015.
What didn’t change with pensions?
Despite widespread press speculation, there were no changes to the limit on tax-free cash (still a maximum of £268,275), no changes to contribution allowances and the overall tax relief system and thankfully, no changes or reintroduction of a lower pension lifetime allowance.
Undeniably, pensions remain an incredibly good value and tax efficient strategy to help finance your future lifestyle.
So, what did change?
With effect from April 2027, most pensions will now form part of your estate and therefore, be subject to 40% Inheritance tax (IHT) on death.
The spouse/civil partner exemption will apply on first death, so no IHT on first death, but IHT will now apply on second death.
So, if you leave your estate to your children or a partner you are not married to, they could have to pay IHT on first death.
Could there be an Income Tax charge in addition to IHT?
Yes, if you die after the age of 75, your beneficiaries will be liable for Income Tax on the pension benefits, after the deduction of 40% IHT has been made.
How might your future spending and IHT plans change?
A common current strategy is to spend other assets e.g. Cash, ISAs, Investments, sell second properties etc., before using your pension (as this had been exempt from IHT). This needs a rethink, and we’ve identified the following points.
- If you were funding your pension or retaining your pension purely for IHT purposes, review immediately.
- If you have reached aged 75 and have yet to extract tax-free cash from your pension, this should be considered for a review. Taking the tax-free cash will mean the funds (now outside of a pension) would only be subject to IHT on death (assuming no other planning) and not IHT and Income Tax.
- Age 75 may also be an appropriate time to consider the purchase of an annuity and the certainty of income for part of your pension fund.
- Assuming you have excess pension funds, taking the tax-free cash now and either making gifts or creating a suitable Trust could be far more attractive than leaving funds in the pension. Taking a regular taxable income and making gifts using the normal expenditure out of income exception could also be considered as an option.
- Death benefit nominations should be reviewed, passing 100% of benefits to a spouse/civil partner may give more opportunities to remove the pension from your estate before second death.
- Payment of pension death benefits into a bypass trust may still offer advantages. Although this won’t escape IHT on first death, the trust will keep the funds outside of anyone’s estate on second death and subsequent deaths. The original main purpose of these type of trusts will be reinstated.
Will these changes actually happen?
There is a consultation period before any legislation is drafted, and potentially there is a small chance of a government U-turn before these rules are enacted, but don’t hold your breath.
Equally, holding out for a change of government and a complete change to these proposals may be overly optimistic as well.
