Inheritance tax on pensions comes into effect in April 2027, bringing unused retirement funds under the scope of the tax for the first time and changing advisers’ approach to client assets.
The policy shift, first announced in the 2024 Budget, has, advisers tell PA, forced them to change their mindset and brought estate conversations forward.
Quilter Cheviot chartered financial planner Megan Rimmer agrees the policy shift has altered the way she works.
“It has shifted the timing and focus of conversations. What was once a more peripheral IHT discussion has become central for many clients, particularly those with larger pension pots”, she explains.
“We are now raising estate planning much earlier and incorporating it alongside retirement income planning rather than treating it as a separate exercise later on.
“There is also more emphasis on scenario planning, helping clients understand not just tax outcomes, but the trade-offs between retaining assets for their own needs and passing wealth on earlier.”
Themis Wealth Management director and chartered IFA Kate Gannon tells PA: “We have certainly had to adapt the way we work.
“Historically, many clients viewed pensions as assets to preserve for future generations, often drawing on other capital first in retirement because pension funds could previously sit outside of the estate for IHT purposes.
“We are now revisiting withdrawal strategies, cashflow modelling assumptions and succession planning with clients to determine whether that approach still remains appropriate.”
Gannon, who is also vice president of the Personal Finance Society, adds: “The PFS is currently undertaking research and many roundtable events with all relevant sectors who can come together to understand the implications of the Great Wealth Transfer, of which I am very proud and honoured to be a part of.
“For example, we are seeing a greater need to model the impact of drawing pension benefits earlier, gifting during lifetime where appropriate, and reviewing the balance between pension assets and other investments.
“There is also renewed focus on protection planning, trusts and ensuring clients have up-to-date wills and expressions of wishes in place.
“Importantly, these conversations are not just relevant for ultra-high-net-worth individuals. Rising property values, frozen nil-rate bands and long-term investment growth mean many more families are potentially exposed to IHT than they perhaps realise.”
Ahmed Bawa is CEO at Rosemount Financial Solutions (IFA). He, too, says the way advisers work has had to shift: “It will be necessary to change suitability letter wording and consider an individual’s overall wealth more closely.
“Personal pensions will become a less appealing product because of the change, however, pensions will still be the most tax-efficient product for most people, especially when you consider the employer’s contribution being added in.”
Bawa adds: “Conventional wisdom was that pensions should be left until the end of the line, due to their favourable death benefits and to potentially help pay for care. After the change, many customers will want to reduce the fund as fast as possible after age 55-57. This is because a pension will become one of the least efficient types of ‘tax incentivised’ products to hold for those keen to leave money to family.
“Pension money could be taxed at 40% and then at 40% again, in some circumstances, which is clearly an absurd situation.”
In practical terms, Quiter Cheviot’s Rimmer explains, there are more frequent and detailed discussions around gifting strategies, including the use of annual allowances, gifts from surplus income and, in some cases, larger lifetime transfers.
“We are also seeing more clients consider whether to draw from pensions differently, particularly where funds might otherwise have been left untouched. That can involve modelling the tax implications of withdrawals alongside the potential IHT exposure.”
Rimmer adds that greater family involvement is also occurring where appropriate: “Where clients are thinking about earlier or intergenerational transfers, it is often helpful to bring children or grandchildren into the conversation to ensure expectations are understood.”
Roll with it
Other firms acknowledge that while the change is big, it’s just another thing advisers have to tackle to maximise client outcomes.
Connor Broadley chartered financial planner Dan McKissock says his day-to-day has not been greatly affected “because discussing legislative change and its impact on clients is already part of the ongoing advisory process. The proposed pension IHT changes are really the latest example of that”.
However, he adds: “Prompted by this, we have taken a more proactive stance.
“Pensions and IHT are topics which cross over into the mainstream press and public consciousness, so clients are arriving at meetings with more questions and, understandably, more concerns.
“We therefore need to address those conversations earlier and more directly as part of the review process.”
McKissock adds that his firm has been very open with clients that the changes could “alter the way we approach retirement income and withdrawal strategies in future”.
“Historically, pensions were often viewed as the ‘last asset to touch’ because of their favourable IHT treatment. Bringing pensions into the scope of IHT potentially changes that equation.
“More broadly, the changes have encouraged more meaningful conversations around intergenerational planning. Previously, many clients saw IHT as an issue for much later in life. Because most people now have some form of pension provision, the proposed changes have made the subject feel more immediate and relevant.
“As a result, conversations that may once have focused purely on sustaining retirement income are becoming more nuanced discussions around family wealth, lifetime gifting, and how clients want assets to flow between generations.
“Even where no immediate action is taken, those are valuable conversations to have.”
Truly Independent head of compliance Elliot Daniels tells PA the changes are “undisputedly unwelcome”, but for the average-net-worth client, there’s no immediate call to action.
“Most clients continue to prioritise sustainable use of their pension assets during their lifetime. With spousal transfers remaining exempt from IHT, the likelihood is that a decumulating couple will still not exceed their combined nil-rate bands on second death.
“For our higher-net-worth clients, it’s difficult even now to find an accumulation product that can compete with the tax efficiency of the pension.
“However, the changes in legislation will still push these clients in later life to reconsider their extraction strategies rather than retaining their pensions as the de facto legacy vehicle. We will be encouraging clients to do this sooner rather than later, to allow time for trust planning and establishing gifting patterns.”
Chapters Financial director and chartered financial planner Keith Churchouse has seen many tax policy changes over the years and regularly communicates these to clients.
“We distribute regular client newsletters, and we have been communicating the change and effects for some time. We have also featured these in our client review documents to ensure there are no surprises for our clients.
“For those affected, there has been a notable engagement from some clients over age 75 who have decided to make changes, such as an increased income draw now, to start to deplete pension funds at a faster rate than before.
“Each case is considered carefully, but there has been a trend in this direction.”
Churchouse told PA that he estimates about 10% of his clients will be affected by the changes, although he cautioned this was “very approximate”.
Challenge of uncertainty
Themis’ Gannon says uncertainty has caused headaches: “One of the challenges has been the level of uncertainty surrounding implementation.
“While the headline announcement gained attention, many of the practical details that advisers and clients need remain unclear.
“Clients are understandably concerned and often ask questions before legislation and guidance are fully developed, which makes managing expectations difficult. We are still waiting for full clarification before we jump one way or another in our practice.”
She explains: “Many of my clients have always sat with assets around the £900,000 to £1m mark with their pensions sitting outside of their estate.
“Our average client has a pension pot worth around £600,000 and if this bill comes into force and they have assets up to the nil rate and property nil rate band allowance – which is £1m if they have made no gifts in lifetime seven years prior to death or any large charity gifts in their death – this will tax their pensions by £240,000 which is a huge loss to the beneficiaries.
“In some cases, the situation is even worse where the pension added to all other assets takes the client over £2m as then they start to lose the property nil rate band, based on rules applying, by £1 for every £2 over, taxing at a further 40p in the £1.”
Gannon estimates that about 90% of her client bank could be affected either directly or indirectly by these changes over time.
Bawa agrees that more and more people could be affected as the changes bed in.
He says: “It could potentially impact most people, including people starting in their 20s today. The current government looks unlikely to remove the fiscal drag on IHT anytime soon, and even the maximum £1m for a couple with children today isn’t very high.
“Looking at an example of a couple who have a house, cash and other assets worth only £500,000, then this would only leave them able to build up a fund of £250,000 each, before the IHT limit is exceeded.
“The pensions could be inheritance taxed at 40%, before then being subjected to income tax at the beneficiaries’ marginal income tax rate.
“The current higher rate tax threshold of £50,270 started in April 2021 and is planned to last until April 2031, which is ten years. By then, many more people will be 40% taxpayers.
“So, people inheriting pensions from their parents could be paying 40% income tax, on a pension that has just been reduced by 40% due to IHT.
“That could make £1,000 of fund worth only £360 after both tax charges have been applied, surely an unintended and unwanted consequence of working hard and saving.”
