Britons are scrambling to move funds out of their pensions savings ahead of new Inheritance Tax (IHT) rules coming into effect next year, experts say. From April 6, 2027 most unused pension funds and death benefits will be added to the value of the estate. Pensions generally sit outside of estates currently, and therefore aren’t included in inheritance tax calculations after you pass away.
But under new rules previously announced by the Chancellor Rachel Reeves, next year they will be added to a pot taxed at 40% over the £325,000 tax-free threshold, known as the nil rate band. There is another band called the ‘residence nil rate band’ worth up to £175,000 that allows a parent also bequeathing their family home to a child or grandchild pass on up to £500,000-worth of their estate outside of inheritance tax, Helen Morrissey, head of retirement analysis at Hargreaves Lansdown previously explained. However, these benefits diminish if you’re handing over a very large estate.
New research from Birmingham-based financial advisors Wesleyan found that nine out of 10 advisers said they had seen an uptick in their clients speeding up pension drawdown in a bid to keep it outside of their taxable estates as the tax reform looms, IFA Magazine reports.
The firm asked advisors how much clients are typically upping their annual pension withdrawals over concerns about IHT, with 74% saying they were increasing withdrawals by between 5 and 15%, with 18% saying by more than 16%, as per the outlet.
Advisers voiced concern about the long-term impact of this approach for their clients, including the risks posed by volatility drag.
This occurs when an investment is removed from a tax-free vehicle when the market is down, diminishing returns you would have had in the long term by pricing out at a low rate.
90% said they were concerned about this, while 88% said they were worried about “sequencing risk” for the clients.
Azets Wealth Management explains that sequencing risk occurs when “markets fall early in retirement and withdrawals continue at the same rate”, meaning the portfolio “must grow much faster later to compensate – a mathematical challenge that is often impossible to overcome”.
Additionally, 93% of advisers identified risks posed to their own income streams when accelerated drawdown occurs during heightened market volatility.
Karen Blatchford, Managing Director of Distribution at Wesleyan said: “While it’s understandable that clients are looking to act ahead of IHT changes, advisers know that increasing withdrawal levels can have significant consequences, especially in the uncertain and volatile market conditions we’re experiencing today.
“That makes it vital that any changes to withdrawal strategies are supported by robust planning and advice to help clients maintain long-term financial resilience.”
She emphasised the increasing importance of solutions to manage short-term volatility like smoothed funds, which can help mitigate the risks of both.
58% of advisers are turning to these funds, as part of wider efforts to diversify clients’ porfolios and shield them from risk.
The Treasury, which has been approached for comment, previously said of the pensions rule shift: “This change has been introduced to prevent pension schemes from being increasingly used and marketed as a tax planning vehicle to transfer wealth, rather than for their intended purpose of funding retirement.”
There are a number of ways to minimise the exposure of your pensions fund to IHT, like tax free gifts (which are subject to various rules and thresholds).
People who are married or in a civil partnership have further options like gifts such as such as the right to pass assets of any value to partners inheritance tax-free.
These beneficaries can also inherit any unused nil rate bands the deceased has, meaning a surviving spouse/civil partner can potentially pass on as much as £1million on death before their estate becomes subject to inheritance tax.
But some taxpayers will have to take into account how pensions could enlarge their taxable estate and pull them into levies they currently aren’t subject to.