Now we have had the Budget, I think this may alter my retirement planning strategy. The significant IHT (inheritance tax) pensions advantage has now gone (or will within two years). 

I am 74, have around £1.5 million in SIPPs largely untouched. I have fixed protection 2014, and my tax-free cash limit is £375,000 less £25,000 taken in 2024.

In view of IHT advantages of pension (until the Budget) I had been taking income from my ISA (value around £600,000) at a rate of £1,000 a month and £1,000 from trading account.

Now it would seem sensible to take a modest amount of tax-free cash and use some to repay the money into the ISA which I think I can do within the same tax year. So far that amounts to £8,000.

I think over next year I might well now need to take some tax-free cash and gift it so provided I live seven years it will reduce those possible additions to my estate. Leaving my ISAs in the tax wrapper. 

Do you agree there is now merit in topping up ISA either from savings of tax-free cash and are there any other things I should consider. 

Eric

Rachel Vahey, AJ Bell Head of Public Policy, says:

Budget changes to pensions tax rules always seemed a possibility. Whereas the chancellor chose to keep the tax advantages of tax relief on pensions contributions and the allowance on tax-free cash lump sums that can be taken in a lifetime, she did choose to change the tax rules on death.

This was perhaps not unexpected. The current rules are very generous; indeed, if a pension saver dies before age 75 then their beneficiaries could be able to take all the income from a pension tax free. If the saver dies after age 75, then income tax will be due on any lump sum or income taken at the beneficiary’s marginal rate of tax. Furthermore, pensions were always kept separate from inheritance tax (IHT).

The chancellor has now suggested changing the rules from April 2027 to include pensions within someone’s estate for IHT.

The first thing to emphasise is this is not yet law. The government is consulting with the industry on how to bring this in. It sounds a simple idea; but in practice it will be very difficult to mesh pension rules with probate rules.

TAKE A MOMENT AND DON’T PANIC

So, before you rush out to change your plans, take a moment. Don’t panic. Think through all your options and if possible, wait a few months for the dust to settle to find out exactly how this will work in practice.

Even if it comes in, the change won’t take place for over another two years, and in the meantime, pensions remain very tax-efficient, and free from inheritance tax.

Although IHT comes with a fearsome reputation, it’s best to remember that very few estates are subject to IHT. There is no doubt this will increase if pensions are included, but it will not affect everyone.

Importantly, any pension money passed on to a spouse or civil partner won’t be subject to IHT. And under the current IHT nil rate bands up to £325,000 can be passed on to other loved ones tax-free before IHT applies, with another £175,000 available if the family home is passed on to direct descendants. Under a ‘second death’ this could mean a potential £1 million nil rate band.

For other cases, where IHT applies, age 75 will still act as a watershed. On death after this age, inherited pension funds will be subject to both income tax and IHT. So, it makes sense, from this age, to take any tax-free cash people are entitled to.

Currently, many people choose to take their funds from other investments, such as ISAs and dealing accounts, and leave their pensions until last. If the change happens, then it’s likely many people, especially if older than 75, will want to revise this order and start to take income from their pension first.

If they take money out of their pension, then they will have to pay income tax on it. They could then move it into their ISA, if they don’t need to spend it, where it will still be subject to IHT, but no further income tax will be paid by the beneficiary who inherits those funds through the estate. This could be advantageous if the pension saver is over 75, has no spouse or civil partner and is a basic rate taxpayer, and the beneficiary is a higher rate taxpayer. But if they pay the same rate of income tax then there may not be many advantages to doing this. The money will still be subject to income tax and IHT.

ALTERNATIVE OPTIONS

An alternative is to gift the removed pension money to others. People will want to use their IHT allowances to do this. For example, everyone has an annual £3,000 allowance, or some could use the rules to allow them to pay a regular income to another if it doesn’t affect their standard of living. Another option is to use the ‘seven-year rule’ which means no tax is due on gifts given if the donor lives for seven years after giving them.

Finally, some pension savers may want to explore setting up trusts for their loved ones. Estate planning however can be complicated, so pension savers, once we understand more clearly the final rules, may want to ask a regulated financial adviser for help in setting up a strategy to suit their personal circumstances.

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