A lot has been said already about the changes to pensions and IHT. We are still over 2 years away as it stands from it coming into force, but it is I think useful to start thinking about what actions the client might want to take as we approach and pass 6th April 2027.
Two potentially important planning points worth looking at specifically are the role of age 75 in pension planning and the potential of gifting pension funds.
Before we go into them, we need to address the obvious caveat. The proposed inclusion of DC pensions in the scope of IHT is not set in law and so is not guaranteed to occur.
As it stands, there are no planned changes to the way pensions are taxed if the plan holder dies after the age of 75 and leaves funds to their beneficiaries. These funds are accessible subject to the marginal rate of tax of the recipient. When combined with a possible IHT charge of 40%, this can mean effective tax rates of between 52% (basic rate) and 67% (additional rate) with the figures slightly different (and potentially worse) in Scotland.
There has always been a need to consider whether to access the PCLS from a pension in anticipation of 75 though this has always come with the risk of bringing the funds into scope of IHT. With an IHT charge applying before and after, from April 2027, it now appears to be much more tax efficient to take the full PCLS available at the point of 75. If death were days after the age of 75, the funds would still be subject to IHT as they were, but now outside the scope of beneficiary tax.
The obvious downside to the above is that you lock out the ability to benefit from another future change to pension rules.
What we will likely see more of is accessing pension funds to gift within the individual’s lifetime. The immediate assumption many might have about this type of action is that it is classed as a potentially exempt transfer (PET) and so subject to a seven-year survival timescale before it achieves the aim.
Withdrawals from a defined contribution pension however, whether in the form of PCLS and/or taxable income, are deemed by HMRC as ‘income’ and so gifts from this source can successfully be classed as ‘gifts out of normal expenditure’ and instantly fall outside the estate for IHT purposes. You would need to establish some kind of ‘regular’ pattern to this, but there is nothing to say this cannot be quarterly/annually as opposed to monthly.
This in theory allows someone to access all the PCLS from a pension and immediately gift it with the funds outside the estate for IHT purposes. As long as a ‘regular’ pattern is created this could be withdrawn and gifted in a fairly aggressive manner to offer a short-term route to moving funds outside the estate.
Combining this action with the age 75 planning point above can result in a substantial tax saving (anywhere between 40% and 67% depending on tax rates and withdrawal strategies of the beneficiary).
Beyond PCLS, it may also be tax efficient to access taxable income within the basic rate band and gift this, having the funds be subject to 20% tax rather than 40%. This type of action can be combined with contributions to the recipients own pension clawing back the original income tax paid.
The standout limitations of the above are that it only works with outright gifts (which may not be desired or appropriate) and stop the client being able to benefit from a reversal or change to pension legislation.
It is important at this stage to not do anything irreversible, given the changes are not technically guaranteed to occur, at least not until the relevant legislation has passed and we approach April 2027. In addition, pensions are still currently free from IHT, and so funds for those affected should ideally stay in a pension until at least April 2027.
Strategies around managing a client’s pension in the context of IHT liability is likely to be highly varied, as all of the below factors could change what is suitable for a particular client:
The ultimate outcome of this is that certain clients will need a lot more ongoing planning and advice, and the result of this planning can in some cases be a very tangible benefit for the client and their family that you can highlight as part of the value you add (and we all know how important demonstrating value is post Consumer Duty!)
If you have any questions on this, we’re more than happy to help. Just drop a line to technical@weareverve.co.uk.
