Pensioners advised not to make drastic changes to retirement plans because of potential IHT changes
By Brewin Dolphin
Warning comes amid rise in pensioners taking taxable income ahead of April 2027
Pensioners are being advised not to make big changes to their spending in a bid to reduce the size of their estate for inheritance tax (IHT) purposes, after a rise in the number of people looking to take more income from their retirement funds, according to RBC Brewin Dolphin.
The wealth manager said that it had received an increase in enquiries from clients looking to withdraw more ‘taxable income’ from their retirement pots, in many cases taking them up to the higher rate threshold of £50,271 in England, Wales, and Northern Ireland and £42,663 in Scotland.
In some extreme cases, individuals are deciding to take up to the additional tax rate threshold of £125,140 – paying 40 percent tax from £50,271 to that figure in England and Wales (the rates differ in Scotland[1]) – and gifting large sums to family members. They are doing this in the hope that it will begin the seven-year countdown for being exempt from inheritance tax and the money can grow with the new owners without having to worry about an IHT liability.
A recent survey of wealthy pensioners by RBC Brewin Dolphin found that 56 percent of respondents plan to spend more of their pension following the government’s plans to include them in estates and make them liable for IHT. Despite the effect this could have on the longevity of their retirement funds, 40 percent said they did not plan to take professional financial advice.
Daniel Hough, wealth manager at RBC Brewin Dolphin, said: “Ultimately, a lot of people would rather pay 20 percent – or 21 percent in Scotland – rather than 40 percent when they pass away. But there is a fine line between passing down wealth as efficiently as possible and enjoying a comfortable retirement.
“There are important discussions you need to have about the sustainability of your retirement pot and that may require scaling back ambitions – or you may find that you have to live with the consequences of your pension running out in your 80s or 90s.”
The latest figures from the Office for National Statistics show a 66-year-old woman has an average life expectancy of 88 years[2]. However, they also have a one-in-four chance of living to 94 and a one-in-ten chance of living to 98. For a 66-year-old man, the average life expectancy is 85 years.
The Pensions and Lifetime Savings Association (PLSA) has calculated that the average single person needs £43,100 a year after tax to fund a ‘comfortable’ retirement, while the average couple needs £59,000 a year after tax. This would cover all your basic needs as well as some luxuries, such as a fortnight on a four-star Mediterranean holiday, replacing your kitchen and bathroom every ten to 15 years, and replacing your car every five years.
RBC Brewin Dolphin’s analysis shows that if someone retired aged 66 with a £500,000 pension and started withdrawing net income of £43,100 a year (£50,887 before tax), their pot could run out by age 77. This assumes the fund grows at an annual rate of 5 percent after fees and the income increases annually with inflation (assumed at 2 percent) and does not factor in the state pension. Starting with a £750,000 pension, the pot could last until the age of 84.
Remember, the state pension could boost your income by around £11,973 a year, perhaps enabling you to withdraw a lower amount from your personal pensions. If, for example, you started withdrawing net income of £31,127 a year (£38,914 before tax) from a £500,000 pension, your pot could last around four years longer to age 81 (based on the same assumptions as above). For a £750,000 pension, you could still have money left in your pot at age 93.
Figures show someone with £500,000 in pension savings who buys an annuity at age 66 could currently expect annual retirement income of just over £30,000 a year (before tax)1. This is less than the £43,100 net annual income which the Pensions and Lifetime Savings Association says is required to fund a ‘comfortable’ retirement for the average single person2. You may also be entitled to the full state pension, which is currently £230.25 per week (just under £12,000 per year).
Daniel Hough added: “The general rule is that a ‘safe’ withdrawal amount is 4 percent of the total pot per year. Of course, this depends on the underlying investments – a higher risk portfolio might allow for higher returns and, therefore, withdrawals, but that will come with a lot more volatility. With that approach, you might be looking at double-digit returns some years and then potentially significant losses during others.
“If you’re considering withdrawing significant amounts of additional money from your pension pot, speak to a professional financial adviser about the long-term effect this may have on your retirement plans. Even a single percentage point can make a big difference over 20 or 30 years, potentially leaving you short when you may need financial support most.”
Ways to manage inheritance tax being applied to your pension
1. Gifting to family
Spouses and civil partners can gift unlimited assets between them. However, when it comes to passing down wealth to the next generation, every individual has a gifting allowance of £3,000 per year free of IHT. If part or all of this exemption is not used in a tax year, it can be carried forward for one tax year.
Daniel Hough said: “Any gifts made more than seven years prior to the person passing away are exempt from IHT. So, ideally, if you go down this route, you will start early and make it a gradual process.
“If your circumstances don’t allow for that, bear in mind that each individual has a gifting allowance of up to £3,000 per year – that is not a huge amount of money and may take years to reduce a large bill. Anything made beyond that will eat into your nil-rate band if you pass away within seven years of the gift.
“There are also additional one-off exemptions to consider, such as wedding or civil ceremony gifts of up to £1,000 per person, increasing to £2,500 for gifts to a grandchild or £5,000 for a child. If you give these to any family members, keep a record of it.”
2. Use trusts
A trust is a legal arrangement for managing a set of assets on behalf of people and there are many different types of trusts. According to HMRC figures, there were 733,000 registered up to 31st March 2024[3] and, broadly speaking, there are two main distinctions of trusts: absolute and discretionary.
Absolute trusts allow trustees to decide how the assets are given to beneficiaries – as income, lump sums, or when they reach a certain age, for example – while discretionary trusts introduce different classes of beneficiaries, rather than naming individuals.
Daniel Hough said: “For individuals who want to maintain a degree of control, trusts may be a suitable option. These arrangements allow the person to nominate beneficiaries and pay out through income or capital growth at their discretion.
“Trusts can be very powerful tools in that, if the next generation have money problems or split from their partners, the trust’s assets won’t be lost during the bankruptcy or divorce processes. However, they can be expensive to set up, manage, and unwind.”
3. Take out insurance
Taking out a life insurance policy can be another option. While it does not necessarily reduce or remove a potential IHT bill on your estate, you can take out protection for a sum that would cover a future liability – particularly important for estates with illiquid assets that may be difficult to sell in just six months. There are three types of life insurance policy that may be worth considering: term, whole of life, and Gift Inter Vivos.
Daniel Hough said: “If you’re in the situation where your partner has already passed away and you know what the IHT liability is likely to be for your loved ones, you can put protection in place to cover it. It’s a particularly useful option where you want to keep money for retirement or care costs and, while the IHT bill will still be there, the liability will be covered by the lump sum paid out by the policy.
“If you calculate that passing down your estate is going to leave you with an IHT bill of £250,000, for instance, you can put protection in place to cover that amount. If and when this pays out, the proceeds can be put into a trust with named beneficiaries, bypassing the deceased’s estate.
“There are important factors to consider with each type of policy. With a term policy, you are only covered for a set amount of time – say 10 or 20 years. Whole of life cover will, in almost all cases, be the most expensive because they are subject to intense underwriting and will largely be driven by health and age. Meanwhile, Gift Inter Vivos policies are generally the cheapest option, but also provide just seven years of cover.”
Disclaimers
The value of investments, and any income from them, can fall and you may get back less than you invested. RBC Brewin Dolphin are not tax advisers. This does not constitute tax or legal advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.
Important information
About RBC Brewin Dolphin
RBC Brewin Dolphin is one of the UK and Ireland’s leading wealth managers and traces its origins back to 1762. With £57.6bn* billion in assets under management, it offers award-winning, bespoke wealth management services, including discretionary investment management and financial planning.
Its qualified investment managers and financial planners are based in over 30 offices across the UK, Jersey and Republic of Ireland, with a commitment to high standards of client service, long-term thinking and absolute focus on clients’ needs at the core.
As part of Royal Bank of Canada (RBC), RBC Brewin Dolphin is now able to draw on the strength of a global financial institution to enhance the services it provides to clients and to drive further innovation across the business.
*as at 31st October 2024.
Disclaimers
The value of investments can fall and you may get back less than you invested.
RBC Brewin Dolphin is a trading name of RBC Europe Limited. RBC Europe Limited is registered in England and Wales No. 995939. Registered Address: 100 Bishopsgate, London EC2N 4AA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
About RBC
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[1] The Scottish intermediate tax rate of 21 percent applies on income of £26,562-£43,662, higher rate of 42 percent on £43,663 to £75,000, and advanced rate of 45 percent on £75,001 to £125,140
[2] Source: ONS
[3] Source: HMRC