Is it time to update your pension strategy?

The government’s removal of the pensions exemption for inheritance tax could mean adjusting your plans. We explore what this means for you and how having a good cash flow model can show you the way forward.

For the last several years, when it comes to spending money in retirement, many people have chosen to draw from their cash savings, leaving their pensions as the last asset they touch. That’s because it’s been the most tax-efficient way of doing things, avoiding income tax on pension income/withdrawals while allowing the residual pension fund to pass to your beneficiaries free from inheritance tax.

But from April 2027, when pensions will be included as part of your estate, this strategy might need to change.

The good news is that your inheritance tax (IHT) strategy is more flexible than you think.

It’s all about the cash flow

The first thing we do is cash flow modelling, which helps you to visualise your financial future based on a number of ‘what if’ scenarios. It helps you better understand what sort of environment you’re likely to face when you come to retirement – what assets will you have available to draw on? What’s the potential size of your pension? And of course, how much of your residual assets are likely to be left to your beneficiaries based on your anticipated expenditure throughout your lifetime?

Cashflow modelling enables you to work out what category you fall into, so you can tweak your IHT strategy, as well as plan for other tax implications.

You’ll likely fall into one of three categories:

‘Pension funding’ – you always planned to draw from your pension to fund retirement, which means you’ll largely be unaffected by the changes.

‘Middle grounders’ – you have other assets and a pension. You planned to leave your pension until last and spend everything else first, but that plan might need adjusting now.

‘Very comfortable’ – with an abundance of assets and savings, your pension is surplus to your retirement needs, so previously you would have passed this onto your children free of IHT, but this will now need to change.

Here are some more detailed scenarios and questions to be aware of if you fall into these groups.

Pension funding

The Kirbys are still at the accumulation stage and plan to retire in around 20 years’ time. They’ve got a small ISA and about £500,000 in their combined pension and own a property worth around £400,000. With the combination of two nil-rate bands and two residential nil-rate bands, their estate would be under the IHT threshold, even after the April 2027 changes.

What now?

Complete nomination forms – if one of you dies, will your partner need to rely on your pension fund, or should this be passed directly to their children?

The current Budget’s rules don’t have any impact on your IHT liabilities, but you still need to consider your age, health, and life expectancy in cashflow modelling.

 For now, continue accumulating wealth and paying into tax-efficient investment funds, including their ISAs and Pensions.

Middle grounders

The McGoverns have £1m in their pension and investments and property worth around £1.5m. They’re been using their annual gift allowance and making smaller supplementary gifts to reduce the size of their estate. They planned to use their pension when they retire, after the other assets have been depleted.

What now?

Review nominated beneficiaries. The timeline may need to be altered depending on factors including changes in marital status, your age, or the date.

Check whether your pension can facilitate flexible death benefits.

Is it possible to draw more income within lower tax rates now?

How many assets could be surplus on death?

Could you make use of exempt gifts out of surplus income? For example, drawing more income from the pension fund to pay for school fees.

Are there any other tax implications, not just IHT?

Very comfortable

The Bellinghams have assets of more than £2.5m, including a main residence, a rental property and investments of more than £1m. Their pension is valued at £1.5m. They planned to pass it on untouched but now need to optimise their assets to make sure they don’t leave a massive IHT burden in their will.

What now?

Review nominated beneficiaries. The timeline may need to be altered depending on factors including changes in marital status, age, or the date.

Check whether your pension facilitates flexible death benefits.

Can you draw income at lower rates during your lifetime?

Can you make use of exempt gifts from surplus income?

Does tax-efficient growth in your pension outweigh the potential short-term tax cost of taking action now?

Are there any other tax implications, not just IHT?

Could your pension be used to fund an insurance policy to cover the likely inheritance tax liability?

All change in 2027

The pension changes announced last October will continue to make headlines between now and April 2027. And, with two further UK Budgets to go, we can’t rule out further tweaks in the future.

Under the previous rules, it seemed there was an answer for everyone. Now, it’s likely your strategy needs to be more considered than before. However, if you need it, there are options available to change strategy and mitigate tax changes for those inheriting your estate. If you don’t know whether you’d be a ‘pension funding retirement’, ‘middle grounder’ or ‘very comfortable’, then cashflow modelling will help make things much clearer. If you’re unsure how to answer any of the considerations above, please reach out to us.