With many more pensions likely to face a double tax raid as a result of the Inheritance Tax changes announced in the Budget, we look at six ways you can minimise the impact on your nest egg.
Some retirees could lose up to 67% of their pension to the taxman when they die as a result of the Budget tax raid, it has been revealed.
The changes are also expected to cause the number of estates liable for Inheritance Tax (IHT) to soar more than 50% by 2032.
In this article, we'll highlight the catastrophic impact looming for wealthier savers in particular and look at the steps you can take to at least minimise the impact of the chancellor's 'double tax raid' on pensions.
IHT and pensions
As we covered in our Budget explainer, the biggest surprise in the chancellor's October speech was the decision to levy IHT on pensions from 2027.
Pensions are currently tax-free if a person dies before the age of 75, and taxed at the person's nominal Income Tax rate thereafter.
Once the new system is implemented, any estate where someone dies aged older than 75 could face a double tax raid as their pot is hit with both Income Tax and IHT.
Given IHT is currently charged at a whopping 40% on all sums above the thresholds - £375,00 per person, rising to £500,000 if an estate being passed on includes a primary residence - wealthier households in particular will face extortionate tax bills.
Consider the following example provided by financial firm Fidelity: "Where IHT is due, £100 of pension money would be subject to 40% IHT, leaving £60.
"If death occurs after age 75, this money would then be subject to the beneficiary’s rate of Income Tax.
"In the worst case, this would be 45%, resulting in just £33 being received by the beneficiary - an effective tax rate of 67%."
This would be the most extreme scenario, but it's clear even those whose marginal Income Tax rate is at 40% or even 20% will face hefty bills.
According to Government figures, the move could raise £640 million in 2027/28, £1.34 billion the next year, and £1.46 billion by the third year.
What's even more worrying is that many, many more people will be forced to pay the 'death tax' in the coming years: the Institute for Fiscal Studies predicts the number of estates liable for IHT could soar from their current level of just over 4% to approximately 7% by 2032.
Unsurprisingly, many critics have argued that the Chancellor has essentially "pulled the rug out" from under savers' feet.
Essentially, opponents believe the decision will make it more difficult to pass hard-earned money to loved ones when you pass away.
In response to the chancellor's changes, commentators at Hargreaves Lansdown have put together six ways pensions savers can reduce their impact.
October Budget 2024: what it means for your money
1. Act fast to reverse any tax-free cash instruction
If you’ve already taken your tax-free cash prior to the Budget speech but are now having second thoughts, Hargreaves Lansdown points out that you may be able to reverse the instruction.
Many providers offer a cooling-off period, although you’ll need to check the specifics of your deal.
2. Make maximum use of tax relief
Despite what had been widely anticipated in the weeks prior to the Budget, Rachel Reeves didn’t make any changes to pensions tax relief.
At present, savers will still receive a rate of relief tied to the amount of Income Tax they pay.
This means that Basic Rate savers get 20% on any pensions contributions, Higher Rate taxpayers receive 40% and Additional Rate savers bag 45%.
As Hargreaves Lansdown points out, taking advantage of tax relief remains one of the most efficient ways to save for later life.
3. Use your gifting allowances
With pensions now falling under the umbrella of Inheritance Tax, many people will likely try to make gifts to family during their lifetime, rather than after their death.
For example, you can give £3,000 to a person every year and it will not count as part of your estate for Inheritance Tax purposes after you pass away.
Likewise, you can make gifts to family members when they get married.
As a lesser-known rule, you can also give away surplus income.
Under this provision, you can make regular gifts of any value, and these funds will immediately leave your estate for the purposes of Inheritance Tax.
Note, that you may need to prove to HMRC that you are doing so from money you don’t need.
In addition, the taxman’s rules state that the giveaway of surplus income must mean that you don’t leave yourself financially deprived in retirement.
4. Contribute to a family member’s pension
As Hargreaves Lansdown notes, making donations to a family member’s pension is exempt from “recycling rules” – designed to stop you from receiving excessive tax benefits from pensions saving.
It might therefore be worth considering contributing to a partner’s pension or a child’s Junior SIPP (Self-Invested Personal Pension), which allows you to invest without paying Capital Gains or Dividend Tax.
You can contribute up to £2,880 per year into their pension, with tax relief topping the donation up to £3,600.
If you make a larger gift, it will cease to be part of your estate after seven years.
5. Use Junior ISAs to pass wealth to kids
Under current rules, you can save up to £9,000 per year into a Junior ISA, which can be a huge help in getting your children on the property ladder or paying for their education.
As Hargreaves Lansdown says, you can make contributions of up to £4,000 per year and receive a 25% Government tax bonus.
However, your child or family member will pay a 25% early-access charge if they need to use the money for another reason.
6. Life insurance in trust
Should you have concerns about how your family will foot an Inheritance Tax bill, Hargreaves Lansdown suggests you put a life insurance policy in trust.
Under this arrangement, a trustee will organise your policies on the behalf of your beneficiaries.
It can also help you avoid delays with the probate process when you pass away, which is the legal right to deal with a deceased person's property.
Be aware that you’ll need to pay a monthly premium to put a policy in trust, with the exact amount based on your age and health circumstances.