W<\/span>e\u2019ve been challenged by pension planning on Monevator<\/em> before. In particular you may recall my previous post<\/a> on a fictional middle-class duo, Sarah and Stephen, and their pensions-and-IHT-planning saga.<\/p>\n Near the end of that piece, I read the vibes coming from the presumed shoe-in of an incoming Labour government and confidently declared:<\/p>\n Nor do I think it\u2019s likely they bring pensions into people\u2019s estates.<\/p>\n Pensions are trusts, and this would require the overhaul of quite a bit of trust law.<\/p>\n<\/blockquote>\n Well, chalk this up as another episode in the long drama of Finumus Predicts Poorly<\/em>.<\/p>\n And let it serve as another reminder not to take anything as anything as gospel<\/a> from semi-random internet pundits. Me included!<\/p>\n That said, I did hedge my bets in a later<\/a> article, warning:<\/p>\n Over the long run, I doubt \u2018beneficiary\u2019 pension pots compounding tax-free for decades will survive the \u2018Someone has \u00a31bn in their pension\u2019 headlines. We\u2019re not America.<\/p>\n<\/blockquote>\n But I didn\u2019t think the unravelling would come this<\/em> quickly\u2026<\/p>\n Starting April 2027, defined contribution (DC) pensions will fall within the scope of inheritance tax (IHT). <\/p>\n While the exact legislation is still to be hammered out, let\u2019s assume the worst. (Generally the best approach to tax policy, especially for cynics).<\/p>\n Labour\u2019s moving of the goalposts is not just a headline grabber. Bringing DC pensions into the scope of IHT creates significant <\/em>problems, especially for those who\u2019ve been diligently building retirement savings to double as intergenerational wealth vehicles.<\/p>\n Let\u2019s have a quick refresher on how the system presently works.<\/p>\n This structure has long been a favorite of tax planners for IHT minimisation.<\/p>\n Combining generous tax relief on contributions with tax-deferred growth and IHT-free transferability? It\u2019s a potent cocktail \u2013 akin to having your cake, eating it, and then feeding it to your heirs in perpetuity.<\/p>\n But come April 2027, the party\u2019s over.<\/p>\n Under Labour\u2019s proposed new rules:<\/p>\n One or the other might have been tolerable.<\/p>\n But both? It\u2019s brutal.<\/p>\n [Editor\u2019s note: The early consensus from Monevator readers is that Finumus\u2019 worst-case scenario is excessively fatalistic. The suggestion so far, they note, is that <\/em>the income tax regime on inherited pensions will remain the same<\/strong><\/em>. This would mean no income tax if the donor dies before age 75. We will not know for sure, of course, until we see the proposed legislation. Please read and add your own thoughts in the <\/em>\u200bcomments<\/em>\u200b<\/a>.]<\/em><\/p>\n To illustrate why Labour\u2019s new rules could be so tough, let\u2019s compare some outcomes.<\/p>\n If you start with \u00a3100 in a pension, under the current system, your descendants can keep that \u00a3100 compounding tax-free forever (as long as they never draw it down). <\/p>\n What about under the new system? Well, that same \u00a3100 shrinks to mere pennies over five generations due to compounding taxes.<\/p>\n Changing the rules like this effectively introduces a wealth tax of ~1.33% per year<\/strong> on assets in pensions.<\/p>\n And unlike other assets, pensions are trapped<\/strong>. You can\u2019t give them away to sidestep IHT \u2013 or at least you can\u2019t without paying income tax.<\/p>\n I feel another meme coming on\u2026<\/p>\n Let\u2019s revisit our fictional friends from my previous post<\/a>, Sarah and Stephen.<\/p>\n The doughty duo were last seen convincing Sarah\u2019s parents to fund their pensions to the tune of \u00a3360,000 to save both IHT and to give them a bit of financial breathing room.<\/p>\n Since then:<\/p>\n Their net worth<\/strong> (including gross value of pensions) now sits at \u00a37.3m.<\/p>\n If they die tomorrow, their estate would owe \u00a31.58m in IHT<\/strong>. But if they die post-April 2027? That IHT bill balloons to \u00a32.7m<\/strong>. That\u2019s an extra \u00a31m gone to HMRC.<\/p>\n Over dinner, Sarah unveils the grim numbers to Stephen, her spreadsheet glowing ominously on the kitchen table. Stephen\u2019s initial reaction is one of stoic resignation.<\/p>\n \u201cThe kids will be fine,\u201d <\/em>Stephen says, sipping his wine. \u201cWe\u2019ve given them a great education, a leg-up most people can only dream of. They\u2019ve got to stand on their own two feet eventually.\u201d<\/em><\/p>\n Sarah isn\u2019t so sure: \u201cFine? In this economy? You have remembered that they are both studying humanities?\u201d<\/em><\/p>\n Sarah reminds him that the cost of housing has ballooned since their own days as scrappy young professionals.<\/p>\n \u201cEven with decent jobs, Amelia and Jack will struggle to buy a home in London unless we help,\u201d <\/em>she argues. \u201cAdd in student loans, higher taxes, and the cost of living \u2013 they\u2019ll be working harder for less. And now, a good chunk of what we planned to leave them will be eaten by this new pension tax double-whammy.\u201d<\/em><\/p>\n Stephen sighs but doesn\u2019t counter. Sarah has a point. Their \u00a32.7m post-2027 IHT bill could be as much an entire post-tax career\u2019s worth of income for their kids.<\/p>\n That stark figure prompts Stephen reconsider his laissez-faire attitude.<\/p>\n \u201cIt\u2019s not about leaving them a pile of money to blow on avocado toast and electric cars,\u201d <\/em>Sarah presses. \u201cIt\u2019s about giving them options \u2013\u00a0the same options we\u2019ve had. Financial freedom and choices. Security.\u201d<\/em><\/p>\n By the end of the meal (and a bottle of wine), the conversation has veered from pragmatic planning to a lamentation of modern Britain.<\/p>\n They reminisce about the 1990s\u00a0\u2013 lower taxes, cheaper houses, rising wages \u2013 and wonder how it all went so wrong.<\/p>\n \u201cWe\u2019re not just managing money here,\u201d <\/em>Sarah concludes, a bit teary-eyed. \u201cWe\u2019re managing their future.\u201d<\/em><\/p>\n As Sarah digs into spreadsheets, she realises their pensions will need to be spent down \u2013 flipping their previous \u2018pensions-last\u2019 strategy on its head.<\/p>\n This will actually be quite difficult, she discovers as she runs the numbers.<\/p>\n For simplicity, Sarah bundles their SIPPs together and assumes both her and Stephen retire at 55, die at 85, enjoy smooth 3.5% returns, and make no further contributions to their pensions:<\/p>\n If they limit withdrawals to paying basic rate tax, then they\u2019re not going to get it all out.<\/p>\n If they are prepared to go to take a 40% hit though, then maybe they can:<\/p>\n Stephen points out that 30-year gilts have a 5% YTM right now, so Sarah\u2019s 3.5% return assumption is a bit pessimistic. So she plugs that in.\u00a0<\/p>\n Yeah, they are not going to make it.<\/p>\n They should probably just assume that they\u2019re going to have to pay 45% to get it all out at some point.<\/p>\n For now the couple will:<\/p>\n And in retirement they\u2019ll:<\/p>\n The pension changes don\u2019t just complicate Sarah and Stephen\u2019s plans. They cascade upstream to Sarah\u2019s parents and downstream to her children.<\/p>\n As the family\u2019s de facto CFO, Sarah realises she has to juggle three generations of financial puzzles, each affected differently by these changes.<\/p>\n Sarah\u2019s parents, Mike and Mary, are in their early 80s. Their SIPPs are smaller, but still substantial enough to pose problems.<\/p>\n Sarah\u2019s immediate focus is to get Mike and Mary drawing down as much as they can while staying in the 20% income tax bracket.<\/p>\n \u201cEvery pound we can get out now saves Amelia and Jack from paying 40% IHT plus income tax later,\u201d <\/em>she explains to her increasingly confused parents. \u201cIt\u2019s simple maths!\u201d<\/em><\/p>\n Then there\u2019s the tricky issue of skipping a generation.<\/p>\n If Mike and Mary\u2019s pensions pass directly to Sarah, they\u2019ll fall into her estate, creating a tax nightmare. To avoid this, Sarah gets them to\u00a0update their \u2018Expression of Wishes\u2019 forms to redirect those funds to Amelia and Jack instead.<\/p>\n But even this has its pitfalls.<\/p>\n \u201cThe kids could inherit \u00a3420,000 each in their early 20s,\u201d <\/em>Sarah frets. \u201cThat could either set them up for life \u2013\u00a0or ruin their work ethic.\u201d<\/em><\/p>\n Sarah tries not to think about what will happen when their children\u2019s children face the same tax quagmire.<\/p>\n As Sarah continues crunching the numbers, she starts to question everything she thought she knew about pensions. What was once the family\u2019s golden goose \u2013\u00a0a tax-efficient savings vehicle and inheritance tool \u2013\u00a0now looks more like a poisoned chalice.<\/p>\n Let\u2019s take Amelia\u2019s hypothetical future. By 2030, thanks to Sarah\u2019s strategic planning, both children each inherit sizable SIPPs \u2013 say about \u00a3600,000 each, boosted by earlier contributions. These balances are enough to provide financial security, but the tax implications loom large.<\/p>\n For example, there\u2019s going to be little point in Amelia making pension contributions once she starts work. (Unless it\u2019s to avoid marginal tax rates of 20,000%<\/a>.)<\/p>\n If Amelia doesn\u2019t add another penny to her pension but lets it compound at a conservative 3.5% for 35 years, it grows to \u00a32m. At 5%, it hits \u00a33.3m.<\/p>\n A fantastic outcome on paper, clearly. But when Amelia eventually withdraws funds, she\u2019ll face income tax at higher rates. And since she can\u2019t leave her pension untouched for her <\/em>children (thanks to the new IHT rules) she\u2019ll be forced to draw it down aggressively or see it taxed again upon her death.<\/p>\n This realisation leads Sarah to stop contributing to her children\u2019s SIPPs altogether.<\/p>\n \u201cWhat\u2019s the point?\u201d<\/em> Sarah laments. \u201cAll we\u2019re doing is building them a tax headache for the future.\u201d<\/em><\/p>\n Sarah looks at all this in despair, and she honestly doesn\u2019t understand how this can be not \u2018raising taxes on working people\u2019. <\/p>\n She starts to wonder: how bad can five years in Dubai <\/a>really be?<\/p>\n We\u2019d love to hear what people think of Sarah\u2019s situation. In particular, some practical tips amongst the outpouring of sympathy\u00a0\u2013 or otherwise \u2013 would be most welcome.<\/p>\n I\u2019m going to be coming back to wider IHT planning options for Sarah in future posts, and I\u2019ll doubtless be covering: gifting rules, trusts, life insurance, life assurance, family investment companies<\/a>, and possibly at this rate, emigration. I might even talk about (gulp!) annuities<\/p>\n Of course there\u2019s also policy risk to consider. Sarah might retire early, start aggressively drawing down her pension, pay tax on it, and then see a 2029, Farage-led, Reform \/ Tory coalition government abolish IHT on its first day in power.<\/p>\n Want to add something to the discussion? You know where the comment are\u2026<\/p>\n Be sure to follow Finumus on<\/em> Bluesky<\/em><\/a> or <\/em>X<\/em><\/a> and read his <\/em>other articles<\/em><\/a> for Monevator.<\/em><\/p>\n\n
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<\/a><\/figure>\nPensions join the IHT parade<\/h2>\n
The (simplified!) current rules:<\/h3>\n
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The New World Order<\/h3>\n
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<\/a><\/figure>\nMeet the victims: Sarah and Stephen<\/h2>\n
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<\/a><\/figure>\nDinner table drama: a clash of generations and expectations<\/h4>\n
A camel through the eye of a needle<\/h4>\n
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<\/a><\/figure>\n![\"\"](\"https:\/\/i0.wp.com\/monevator.com\/wp-content\/uploads\/2025\/01\/image-1.png?resize=738%2C1024&ssl=1\")
<\/a><\/figure>\n![\"\"](\"https:\/\/i0.wp.com\/monevator.com\/wp-content\/uploads\/2025\/01\/image-2.png?resize=731%2C1024&ssl=1\")
<\/a><\/figure>\nWhat\u2019s the new plan?<\/h2>\n
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The generational headache: from one tax trap to another<\/h3>\n
Pensions as poisoned chalices?<\/h3>\n
What do you think?<\/h3>\n