As I am sure you can imagine, since the Budget on 30th October, I have been poring over the provisions, trying to work out what general guidance I can give my clients before these changes come into effect.
I suppose that is the first thing to say; aside from the Capital Gains Tax changes, which came into effect on the day of the Budget, the most significant changes, as far as most of my clients are concerned, do not come into play until April 2027. This means there is absolutely no hurry to make dramatic changes to one’s financial planning just yet; we have plenty of time to fully digest what is coming and make planning adjustments accordingly. In addition, we are in a period of consultation, and it is possible that the final legislation will differ from what has been proposed.
For the majority of my clients, the most impactful announcement in the Budget was that most defined contribution pensions will now form part of one’s estate on death. The usual 100% exemption between spouses will still apply, but on the second death, the value of any remaining fund will be added to the deceased’s estate to determine how much inheritance tax (IHT) the beneficiaries will need to pay.
The addition of pension funds to estates could dramatically increase the number of estates that will fall into the IHT net and significantly increase the tax bills of those that already do.
The following is part of a submission by investment platform and pension provider A J Bell to the Chancellor on this subject:
The investment platform claims there are flaws in the proposals of Reeves and the Treasury Department to subject unspent pensions to IHT.
The firm said there are “simpler and fairer” alternatives.
AJ Bell suggested using a system similar to the current treatment of ISAs on death or relying on income tax at the beneficiary’s marginal rate.
AJ Bell CEO Michael Summersgill said: “The proposals set out by the government create huge complexity and will delay families from accessing money in a timely fashion following a bereavement.
“In some cases, the proposals will be unworkable and will create financial gridlock in the probate process, especially where assets held in the pension can’t be sold quickly.
“Add to this the fact that the proposals could result in millions of people paying a minimum tax rate of 64 per cent on inherited pensions, and there is a real risk that confidence in pensions will be seriously eroded.”
There will many such representations I am sure and who knows whether they will have any affect.
But what if the proposals are as drafted? What actions might Clearwater recommend in the future?
The following are just my initial thoughts/observations and do not constitute specific advice:
If a client has fragmented pension provision (a number of different pots with different providers), it might become sensible to consolidate these arrangements into a single scheme. If it is going to be the responsibility of pension providers to pay any tax due, I can see this causing enormous probate delays. The simpler the process is for one’s beneficiaries, the better.
It may well be worth incurring some additional fees (within reason) to achieve this objective.
On death under age 75, although any remaining pension fund will be subject to IHT, it will still escape income tax in the hands of beneficiaries, subject to certain limits and the death benefit options available.
Gifts out of income.
If minimising IHT is a primary concern, then it might become sensible to create an income stream from pensions over and above the income required to meet the cost of one’s lifestyle and then simply give away this surplus.
Regular gifts that meet certain criteria are immediately exempt from IHT, which may prove useful for passing funds on to beneficiaries over time.
The effectiveness of this strategy will need to be balanced against the income tax levied on the pension withdrawals as they are taken.These regular gifts could be used to fund a Whole Life Insurance Policy, the sum assured of which has been calculated to meet the IHT liability on the second death. Of course, this strategy will only work if premiums are maintained until the very end.
Taking one’s 25% tax-free lump sum before death will be important. This is because the lump sum in the hands of beneficiaries would lose its tax-free status, potentially suffering IHT at 40% AND income tax at the beneficiaries’ marginal rates.
Pension funds benefit from certain tax advantages that would be lost if one simply took out the 25% tax-free lump sum and placed it in say, a bank account. For this reason, the advice is likely to remain to keep the lump sum within the pension until one needs to spend it or it becomes prudent to give it away. It might be sensible, however, to withdraw the lump sum gradually to maximise ISA contributions. ISAs enjoy similar tax advantages to pensions, but beneficiaries would not suffer income tax on death.
Tax-free lump sums could be invested in a General Investment Account (GIA), where any growth would potentially be subject to Capital Gains Tax (CGT). Beneficiaries would still suffer IHT on death, but CGT rates on withdrawals are currently taxed at a lower rate than income.
The GIAs mentioned above could be placed into trust to ensure that funds reach the right beneficiaries at the right time. Trusts bring complexity and cost into the equation, but they do have a valuable place in certain circumstances.
It might also be worth looking at the respective merits of Onshore and Offshore Bonds, which can also be held in trust.
If one makes a gift of any size, even into certain types of trust, it becomes a Potentially Exempt Transfer (PET). It is potentially exempt because if one dies within seven years, the gift falls back into the estate for IHT. Gifts above the nil-rate threshold (currently £325,000) may benefit from taper relief. Any large gifts should be planned with the above in mind.
Annuities may become more attractive. If any remaining fund cannot be left behind tax-free, then the certainty of a guaranteed income in the form of an annuity might become more appealing to some than it is now.
The above is far from an exhaustive list, but I hope it reassures you that there will be things we can do to mitigate at least partially some of the budget's harshest provisions.
I will write again on this subject once the results of the consultation process are known; this is likely to be in the first quarter of 2025.
If you have any questions or concerns in the meantime, please do not hesitate to contact me.
Yours sincerely,
Graham Ponting CFP Chartered MCSI
Managing Partner
