The 67% Pension Tax Trap: What the 2027 Inheritance Tax Changes Mean for You

Serious Money Podcast

The episode explores the significant implications of upcoming UK tax changes to pensions set for April 2027. Hosts Chris and Gareth detail h

Key takeaways

• From April 2027, most unused pensions will count toward an individual's estate for inheritance tax purposes.
• Beneficiaries inheriting pensions from someone who died after age 75 may face a combined tax burden of up to 67% due to both IHT and income tax.

Main topics

• 2027 Inheritance Tax changes
• Pension taxation and the 67% trap

Notable quotes

The danger is, when these kind of changes are made, 67 %... Pension tax.

Conclusion

The episode highlights the necessity of professional financial plannin

Transcript preview

Speaker 2 (0:00) What I don't want people to think is... It's the end of Speaker 1 (0:02) pensions. A £100,000 pension after Speaker 2 (0:05) inheritance tax, and then they could pay income tax on whatever's left. Speaker 1 (0:09) We're going to assume it's all taxable. £100,000, 40%, £40,000. So that's £60,000 in my pocket. £60,000 in your pocket, no. So at this point now, you'd have to pay £85,000 tax on a £100,000 pension. The danger is, when these kind of changes are made, 67 %... Pension tax. It's not quite as simple. Speaker 2 (0:34) Welcome to the Serious Money Podcast. I'm Chris. And I'm Gareth. This is the podcast for unfiltered money talk for people who have outgrown the basic stuff. And today we're going to be talking about pensions and tax changes, which has been in the news quite a lot recently, mate. That's all I'm seeing a Speaker 1 (0:50) little over the news. Probably because your news is a little bit skewed towards personal finance. Yeah, good point, actually. Speaker 2 (0:56) So from 2027... My pension counts as part of my estate for inheritance tax. And if I die after age 75, my kids already pay income tax. And that's not changing. No. So a £100,000 pension after inheritance tax becomes £60,000 after 40 % inheritance tax. And then they could pay income tax on whatever's left. Speaker 1 (1:20) Yeah, up to their highest marginal rate. So up to 45 % in reality, 20, 40 or 45%. How have we ended up in this situation? Whatever it is, whether you look at the Tories or Labour, they don't like pensions. And it's something they've been wanting to do. They've talked about a tax in, you know, changing the way tax-free cash is paid and having less of that. And I think this, for them, they see as probably an easy money grab, really. But I think you know the stats on this, and you'll probably come to that in a bit, is that actually, is it really actually going to grab that much money of any real relevance? 0.6 billion, I think, in 2027, Speaker 2 (1:55) 2028 is what it's going to raise. And I think I read somewhere that that's sort of enough to fund sort of the military budget for a week or so, to put it into context. But the thing is, when the government changes legislation, behaviour changes as well. So I don't know whether those figures are just based on sort of, you know. Speaker 1 (2:16) I don't know. I do wonder where they get some of these figures from and how they think it's going to affect it. But it's going to start affecting a lot more people than it should do, really. Some people will have kind of old kind of workplace pension, which maybe they transferred out of. They might have been in a defined benefit scheme and transferred out another big lump sum because they wanted the flexibility to leave it to their kids and have more flexible access to it. Now, they would have come from potentially blue-collar jobs. Which now has made them, their estate, much bigger than it ever would have been. Because they might only have like a three, four hundred thousand pound house, but they're sat on quite a big pension pot, which they can't really, they're not really eating into because they're not spending it at all. And it's now going to become taxable. So historically, financial Speaker 2 (3:00) advisors were using pensions and everyday people were using pensions as like inheritance tax planning tools because you throw money into a pension. incredibly tax efficient and it still is tax Speaker 1 (3:12) efficient and what I don't want people to think is it's the end of pensions it's the end of pensions it's not it's an interesting one like yeah I think as financial planners we use we always use it historically twofold one it's it's a retirement savings vehicle yeah yeah Speaker 2 (3:28) and Speaker 1 (3:29) a really really tax efficient one of that because of you know the tax relief you get going in your employers paying into it so it's free money if you in a workplace scheme Speaker 2 (3:38) National Insurance Tax Relief as well, their fifth salary sacrifice. We'll get on to Speaker 1 (3:41) that. Speaker 2 (3:41) Which they're coming after that as well. Speaker 1 (3:42) But yeah, it's an incredible tool for retirement. And I know it's had a bad rep over the years, probably miscommunicated that, but we can come on to that as well later. But also, it was also used as effectively like an inheritance tax shelter because pensions weren't... classed as part of your estate for inheritance tax so you could grow it all the way to death and you could pass it on to your kids yeah you know under 75 no tax on when they draw it over 75 taxed at marginal rate but no inheritance tax on it okay so still a great kind of vehicle obviously those rules are changing now so and and as planners we would generally say okay when we come to retirement let's potentially not draw down on your pension until we really need to maybe we would have drawn down up to the personal allowance rate the 12, 570. Take some tax-free cash, maybe. Speaker 2 (4:31) Take some Speaker 1 (4:31) tax-free cash, maybe. But then, otherwise, use all their other kind of things, like their ISAs, any kind of cash money. Yeah, because everything else forms part of Speaker 2 (4:38) the Speaker 1 (4:38) estate. Yeah, because everything else forms part of Speaker 2 (4:40) the Speaker 1 (4:40) estate. Now, that whole methodology is going to have to change. And we haven't, I haven't worked out how that methodology is really going to work yet. I'm probably not going to until we actually get there, because there is the cynic in me which says that things might change by the time we actually get to April 2027. April 2027. Speaker 2 (4:54) I think they're still hashing out some of the rules. Probably spent about 45 minutes before the podcast trying to disentangle some of the nuances of the rules together. But at the end of the day, they're still kind of, they're still yet to be Speaker 1 (5:07) fully sort of. Yeah. You know, but from a point of view of pensions, just to kind of caveat this, I think, is still the best long-term investment tool. Agree. And I think Speaker 2 (5:19) the danger is with all, but this is the whole thing. The danger is when these kind of changes are made. Yeah. Like, the government knows that this creates headlines. 67 % Speaker 1 (5:30) pension tax or whatever. Yeah, because there's that double taxation thing which has been kind of bandied around. It's not quite as simple as the way it's kind of coming across. There is a double taxation, but it all kind of depends on... But whose job is it to educate people about this? Like, we're here educating. It's going to be an absolute headache for not only... the people administering the estates, the beneficiaries, the executors of the estate, but also for the companies that hold the pension pots. Yeah. Speaker 2 (6:01) But everything's going to fall on you as the executor to do this. Which are, and the executor are basically the loved ones. Yeah, it's generally going to Speaker 1 (6:08) be Speaker 2 (6:08) the loved ones. The mourning relatives of Speaker 1 (6:09) the deceased. Speaker 2 (6:09) Yeah. After six months. Speaker 1 (6:11) We're going to have to navigate these rules. And I do think that probably as financial planners, we're probably going to come a lot more into play again with things like that. Speaker 2 (6:19) Yeah. Speaker 1 (6:19) Because we're going to understand those rules and how to navigate it a lot better than, I guess, the layperson because we're going to be in the weeds doing it all the time. Speaker 2 (6:28) But I guess the angle I'm coming from in all this is the government needs to be doing a better job of saying, yes, we've made some changes, but pensions are still excellent vehicles. They need to be promoting pensions. Yeah, they do. And also... sort of pushing back a little bit against some of the sensationalist headlines around this area. It is a big change. Yeah, a huge change. But the headlines are always going to take it to the sort of end. They're always changing Speaker 1 (6:57) things with pensions. Yeah. Like, I think if you go back to the, you've got a timeline there of what's kind of happened since. 2006. Which is a day, which, funny enough, was called Pension Simplification Day. And they didn't make anything simple. they actually made it more complex. It was kind of like pension unsimplification day. Speaker 2 (7:17) It's always been a bit complex. It's always been complex because your Speaker 1 (7:20) pre-A day stuff is where you had a lot of your kind of guaranteed benefits, your enhanced tax-free cashes, and your guaranteed annuity rates. So lots of kind of quirky benefits, which is actually something you have to be very careful of when you're looking to do the consolidation exercise. And just to touch on that, is that there's a lot of talk about you should probably pensions into one pots and things like that. And that's Speaker 2 (7:43) a Speaker 1 (7:43) whole nother episode, which we will cover that at some point. Speaker 2 (7:46) But Speaker 1 (7:46) be very careful when you're looking at consolidating pensions. If you're in a pension, which you had pre-2006, it's very likely you may have some of these, what I like to call quirky benefits, which might be guaranteed incomes, enhanced tax-free cashes. If you move those, you will lose them. And if you're doing it yourself, A lot of these providers won't tell you that. They'll just transfer it. We always do the research to find out what these benefits are and then weigh up the pluses and minuses of it and then decide whether actually it should be staying where it is or it should be moved because it works for your benefit from a planning point of view. And those benefits could be a bit more tax-free cash? Here's Speaker 2 (8:26) an Speaker 1 (8:26) example. So we had a client recently. He came to us. He had about eight pension pots. And all those eight pension pots, there was two in there. One had a guaranteed annuity rate. So what that is, is a guaranteed income for life. So the pension would pay you a set percentage of the money invested for the rest of your life. Okay, so it guaranteed you selling your pension to the insurance company. It'll pay you a guaranteed income for life, index linked, or it depends on what the benefits are in there. So it had one of those in there. It also had enhanced tax-free cash. The enhanced tax-free cash was 51 % of the pot. Standard is 25%. So for example, say you got 100,000. 25%, £25,000 is tax-free. In this instance, it was £51,000 tax-free. If he transferred both of those, he would have lost all his benefits. But this is the danger of, Speaker 2 (9:12) obviously, he'd sought financial advice from you. Yes. But if he'd gone on to pension, you know, some online pension Speaker 1 (9:20) consolidation... Speaker 2 (9:21) On pension Speaker 1 (9:21) consolidation, it's very unlikely they wouldn't have warned him of this. He might have got a Speaker 2 (9:25) letter, Speaker 1 (9:25) but would he have read the letter? Speaker 2 (9:27) He Speaker 1 (9:27) would have just gone ahead and transferred. You would have been none the wiser then. So in that instance, so this person was retiring. Now the actual pensions are really poor. One really expensive, really poor investments, really poor performance in them, not much choice in them. So we looked at it and we looked at like, for example, the guaranteed annuity rate was actually really poor. It wasn't a good guaranteed annuity rate. We get better in the open market. And from discussions with him, he was like, look, I don't want a guaranteed income. I want the flexibility to draw it down. Okay, so the decision was to move that one. Now what we did with the... Enhanced tax-free cash is we took the tax-free cash at 51 % and then transferred the residual. Speaker 2 (10:03) But all this stuff is so complicated. So he's got eight different pensions, always slightly different rules.