The retirement rethink: is it time to tear up your pension plans?

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Grieving families will soon face the prospect of having to pay out tens of thousands of pounds to the taxman on pensions that they inherit.
Retirement pots are a uniquely efficient way of passing on wealth to the next generation — they typically do not form part of your estate and are free from inheritance tax.
But this will change from April 2027 when most pension funds will be included in an estate for inheritance tax (IHT) purposes and could trigger a hefty tax bill. They will be liable regardless of whether money has already been taken out of them.
A key strategy of many savers’ retirement planning is to use other assets to provide an income and leave pension savings untouched, to be passed on free of inheritance tax when they die. But the new rules announced by the chancellor last week will have thrown these plans into disarray.
We look at the potential impact of the decision.
If you die after the age of 75 your beneficiaries pay income tax — at their usual rate — on money taken out of any pension they inherit. After April 2027, if the pension was liable to IHT this would first be deducted and then the beneficiaries would pay income tax on the amount they withdraw from what they have inherited — creating an effective tax rate of up to 67 per cent, assuming the pension was fully taxable.
In the first year of the changes the government has said about 38,500 estates will pay more IHT — an additional £34,000 on average. These estates would pay £169,000 on average before the changes.
Everyone can pass on £325,000 free from IHT when they die and in most cases those who are leaving a family home to direct descendants get an additional £175,000, as long as their estate is worth less than £2 million. Spouses can inherit a partner’s allowance, so a couple can pass on up to £1 million tax-free.
Laura Walkley from TWM Solicitors said: “It’s common to see pension pots worth several hundred thousand pounds being inherited. With the IHT threshold effectively being £1 million for a married couple, the addition of a pension pot of that size is going to mean a lot more estates paying the tax.”
Anything left to a spouse or civil partner is exempt from IHT — including pensions — and this will not change after April 2027.
Ollie Saiman from Six Degrees, an advice firm for high-net-worth clients, said: “Leaving pensions untouched to pass on free of inheritance tax is really common and a clean way to pass on money to the next generation.
“Bringing pensions into estates will have a big impact on savers with significant pension pots — across our clients it will mean a 15 to 20 per cent increase in IHT liabilities.”
Pensions will soon no longer be the golden egg of inheritance planning and it might be tempting to now raid your retirement pot — either spending the money or giving it away to family in your lifetime.
You can usually take 25 per cent of your pension tax-free, up to a limit of £268,275, once you turn 55 (although this is rising to 57 from April 2028). But this approach has its risks.
“Gifting is still a very effective way of potentially reducing your IHT liabilities when done right, but if you are still relatively young then saving into a pension is still tax-efficient. And if you take your lump sum out it’s no longer compounding wealth for you and you are potentially losing out on investment growth,” Saiman said.
Withdrawals above the 25 per cent lump sum are taxed at your marginal income tax rate, which Craig Rickman from the investment platform Interactive Investor, said could negate any potential IHT benefits of taking money out of your pension.
He said: “We are likely to see more people draw from their pensions sooner and either spend the money or gift it to loved ones. But people still must tread carefully — if you took out particularly large sums you could be hit with 40 per cent or 45 per cent income tax.”
If your aim is to save tax it’s usually best to avoid making pension withdrawals that — when added to other income — exceed £50,270 a year, when the 40 per cent higher rate of income tax kicks in.
For many, the only way to shield money from IHT from April 2027 will be to gift it in their lifetime or to spend it (but not on assets that will remain in their estate). Up to £3,000 can be given away each tax year without the risk of it later being included in your estate, and this can be given to one person or split between several. Any unused annual allowance can be carried forward by one tax year.
You can also give £5,000 tax-free to a child or stepchild getting married and £2,500 to a grandchild. If you want to pass on bigger amounts then the seven-year rule could help — survive seven years after making the gift and it will fall outside your estate and be free from IHT.
If you die between three and seven years after giving the money, the relief is tapered and IHT is charged (on anything over the tax-free allowance) on a sliding scale from 32 per cent to 8 per cent. If you die within three years of making the gift IHT is charged at the usual rate of 40 per cent.
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It is also possible to make regular gifts from your excess income that are exempt from IHT without it counting towards your annual tax-free allowances — regular withdrawals from pensions count as income under this relief.
But there are strict rules. The gifts cannot affect your standard of living, they must be regular and made out of income, rather than capital, such as proceeds from a property sale. HM Revenue & Customs is hot on this relief so keeping detailed records so the executors of your estate can prove the gifts qualify is essential.If you are considering giving large chunks of your retirement pot away in your lifetime, it is essential that you leave enough for yourself in later life. Work out a cash flow that includes any care costs you might need, even if you are in good health.
Trusts have significant IHT benefits and there is no limit on how much can be gifted to a bare trust, which is typically used to give assets to younger generations, and as long as the donor lives for seven years after making the transfer there will be no IHT charge. Rickman predicted an increase in the use of trusts for IHT planning in light of the rule changes announced in the budget.
Once a benefactor has set up a trust they cannot change their mind about giving away the money and who it goes to, and the beneficiary will have full control once they turn 18, regardless of their circumstances.
Discretionary trusts offer more flexibility and control over who gets assets and when, but IHT rules are stricter. Any assets above the £325,000 IHT-free allowance put into a discretionary trust are immediately liable for IHT at a rate of 20 per cent, and are then subject to a 6 per cent IHT charge every ten years. If you die within seven years of putting assets into a discretionary trust, the usual 40 per cent rate will apply.
Trusts come with their own costs and administrative complexities so it is important to get professional advice.
Whole of life insurance policies can help to cover an a IHT bill, but they can be pricey and the age that you take out the cover will affect your premiums. The younger you are and the better your health, the cheaper your monthly costs are likely to be.
A joint whole of life policy sufficient to cover a £203,000 IHT bill would cost a couple £200 per month, assuming they were aged 55 and non-smokers in good health, according to analysis by Carr Consulting and Communications, which specialises in the financial sector.
Saiman said: “Life cover is a common strategy to help beneficiaries settle an IHT bill and we anticipate a significant uptick in the levels of insurance families have in place. If you already have life cover in place, you will need to top it up if you have a sizeable pension pot that will soon be included in your estate.”
Rickman said anyone who chooses this route should place the policy in trust. “Otherwise the sum will be added to your estate and could increase your IHT liability.”
IHT needs to be paid to HMRC within six months of someone’s death, otherwise interest starts racking up — at the moment the rate is 7.5 per cent. IHT typically has to be paid before probate is granted, but any assets held solely in the name of the deceased cannot be accessed without a grant of probate, which can cause big problems when trying to pay a hefty bill.
From April 2027 this process is likely to get much more complicated. The government is still consulting on how it will levy IHT on pensions, but last week it said the executors of an estate would have to notify pension schemes of a death and request information such as fund values or death benefit entitlements.
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The pension scheme would then report to HMRC and pay its share of the IHT bill, while the estate would pay the balance of any IHT bill which does not arise from a pension. Steve Webb from the consultancy Lane Clark & Peacock, and a former pensions minister, warned that it would be a “bureaucratic nightmare” for grieving families.
He said: “Bereaved relatives already face huge challenges in winding up the financial affairs of a loved one. Including pensions within the scope of IHT will add greatly to the burden. People will need to know which pension schemes to contact, will have to rely on the efficient administration of pensions — with the whole process on hold until the slowest scheme has replied — and then potentially wait months more before death benefits and pension balances can be released by the scheme.”