Over 75? Why the pension inheritance tax changes could affect your financial planning

The forthcoming IHT changes do not mean pensions have lost their value.

Pensions remain a highly tax-efficient way of saving for retirement. Investments within a pension can generally grow free from income tax and capital gains tax, while contributions can attract tax relief.

For higher and additional rate taxpayers, this can make pension contributions particularly valuable. They can also be especially effective for people with income between £100,000 and £125,140 where pension contributions may help restore some or all of the personal allowance.

For business owners considering passing their company to the next generation, pension contributions can also provide an efficient way of extracting profits from the business to build a fund for retirement.

“The changes from 2027 shouldn’t distract from the fundamental benefits of pensions,” says Simon. “They remain an extremely valuable way of providing for your own retirement and potentially for a spouse or partner.

“What is changing is how pensions need to be considered as part of your wider estate planning.”

Under current pension rules, the tax treatment of inherited pension benefits depends in part on the age of the pension holder when they die.

Where someone dies aged 75 or over, beneficiaries will generally pay income tax at their marginal rate when drawing taxable inherited pension benefits.

From April 2027, unused pension funds may also form part of the deceased’s estate for inheritance tax purposes. This creates the possibility of both inheritance tax applying to the estate and income tax subsequently being paid by beneficiaries when pension funds are drawn.

For people over 75 with significant undrawn pension funds, Simon believes this makes reviewing their position particularly important.

“It may no longer make sense simply to leave as much as possible within the pension for beneficiaries,” he explains.

“The important thing is to look at the pension alongside the rest of the estate, understand who you ultimately want to benefit and consider the different taxes that could apply.”

One area worth reviewing is whether to take available tax-free cash. 

It is expected to remain possible to defer taking tax-free cash after age 75. However, Simon believes the attraction of doing so could be reduced once pensions become subject to IHT. 

For someone over 75 who has not yet drawn their available tax-free cash, taking it before the new regime comes into effect may therefore be worth considering. 

That does not mean withdrawing pension funds automatically makes sense. Taking money out of a pension moves it into the individual’s wider estate, where it may itself be subject to IHT if it is retained. 

The appropriate decision will depend on what happens to the money afterwards, the value and composition of the wider estate, the needs of the individual and their family, and the tax position of the intended beneficiaries.

The changes could also prompt some retirees to reconsider how much income they draw from their pension.

Rather than preserving the pension primarily for inheritance, it may be appropriate to use more of it to meet living costs, allowing other assets to be considered as part of wider estate planning.

For some people, improved annuity rates in recent years may also make using part of a pension to secure a guaranteed retirement income worth exploring. Having greater certainty over future income could potentially give someone more confidence when considering whether other assets can be gifted.

Simon says: “Later-life planning is increasingly about looking at all of your assets together. If you know you have sufficient secure income to meet your own needs, that can give you greater clarity when considering what you can afford to give away during your lifetime.”

People whose retirement income comfortably exceeds their expenditure may also want to consider whether regular gifting forms part of their estate planning.

Under the normal expenditure out of income exemption, qualifying gifts made regularly from surplus income can potentially fall outside the estate for IHT purposes, provided the relevant conditions are met and the donor can maintain their normal standard of living.

Drawing pension income and making regular gifts could therefore be appropriate in some circumstances, although careful planning and record-keeping are important.

Another option for some families could be using additional pension income to fund a whole-of-life insurance policy designed to provide beneficiaries with funds towards a future IHT liability.

Again, neither strategy should be considered in isolation. The tax consequences of drawing additional pension income need to be weighed against the potential estate-planning benefit.

The 2027 changes also make beneficiary planning increasingly important.

Rather than automatically leaving pension benefits to a spouse or adult children, families may want to consider the income tax position of different beneficiaries.

For example, an adult child who is an additional rate taxpayer could face a very different tax outcome from a grandchild with little or no taxable income.

In some circumstances, trusts may also have a role where families want greater control over how and when wealth passes to beneficiaries. However, trusts have their own tax implications and require specialist advice.

The important point is that pension nominations should form part of a wider estate plan rather than being considered separately.

Pension planning is only one part of preparing for later life.

Simon recommends reviewing the wider arrangements around your finances and family at the same time. This should include ensuring your Will reflects your current wishes, reviewing pension beneficiary nominations and making sure your executors know where your pensions and other assets are held.

Having appropriate Lasting Powers of Attorney in place can also be important, enabling people you trust to help manage your affairs if you are no longer able to do so yourself.

Where appropriate, involving children or other family members in conversations about your plans can help ensure they understand your wishes and reduce the potential for uncertainty later.

Lifetime gifts should also be considered carefully, including whether assets should be transferred outright or through a trust and whether available gifting exemptions are being used effectively.

Although the pension IHT changes are not due to take effect until April 2027, later-life financial planning often takes time.

For people over 75, particularly those with significant pension savings or estates potentially exposed to inheritance tax, now is an opportunity to review whether an existing strategy remains appropriate.

“There isn’t one answer that will work for everyone,” says Simon.

“For some people, taking tax-free cash may make sense. Others may benefit from drawing more income, gifting surplus income or reconsidering which assets they leave to different members of the family.

“The important thing is to understand how the different pieces fit together. Your pension, other investments, property, income requirements, tax position and wishes for your family all need to be considered as part of the same plan.”

The forthcoming changes provide a good reason to review retirement and estate planning arrangements before April 2027.

Old Mill’s financial planning and tax specialists can work together to review your pension, income requirements, wider estate and plans for passing wealth to your family, helping you understand the options available and the potential tax implications of different approaches.

To discuss how the changes could affect you and your family, speak to Simon Valentine-Marsh or contact your usual Old Mill adviser.