Fears over IHT raid on pensions could also be ‘overcooked’, says cash skilled BILLY BURROWS

William Burrows runs The Annuity Project and is a financial adviser at Eadon & Co.

There is no doubt that Rachel Reeves’ announcement that from April 2027 unused pension pots will be subject to inheritance tax is bad news, but is it as bad as many people are saying?

Recent headlines about this matter such as Reeves’ inheritance tax raid puts millions at risk of poverty in later life or Inherited pensions could see ‘double tax hit’ of up to 70.5 per cent, paint a bleak picture and cast a dark shadow over pensions.

But I don’t think we should be so despondent or worried – it should not adversely affect the majority of pension plans and where it does there are some simple things that can be done to reduce the impact.

To be clear; those with very large pensions will probably end up having their unused pension pots being liable to inheritance tax but even those with above average pots should be able to avoid it.

Why do I think this issue is overcooked? There are three reasons:

– The new rules should only affect those with very large pensions

– More people will benefit from taking income from their pensions

– There are simple and legitimate ways of mitigating inheritance tax.

One of the problems with pensions is that people have a different perception of capital compared to income.

A £1million pension pot looks like a lot of money whereas £40,000 per annum looks like less money.

But in pensions term they are the same because £1million buys a £40,000 per annum inflation linked pension for a married couple aged 65 and 60.

If you don’t want to lock into a guaranteed pension you can invest in pension drawdown and take the same amount of income and with standard assumptions this will last until your normal life expectancy but there are risks involved.

If investment returns are lower than expected you run the risk of running out of money before you die if but if returns are higher you will have money left to leave to your family

According to the Pensions and Lifetime Savings Association, a married couple need a retirement income of £59,000 per annum for a comfortable retirement, and that is after tax and does not include housing costs or care fees.

The point is that most people will need to use some or all of their personal or company pensions on top of their state pensions to get this amount of income.

Of course they can use their Isa, savings and investments instead of their pension but how many people have enough personal wealth to generate this amount of income without touching their pension?

Don’t forget, it is sensible to keep a decent ‘rainy day’ fund with savings so not all savings should be used for income.

Income from Isa savings does not attract income tax whereas income from pensions does so it important that people get advice as to the most tax-efficient way to arrange income in retirement.

All of this means that even though many people think they will leave their pension pot to their children, in reality they may use most of their pension pots to provide income for themselves and their spouse/partner.

If the pension holder dies first, their pension pot can pass to their spouse or civil partner without any inheritance tax liability and on their death, there will be a £1million inheritance allowance to use up, if they leave their home to their direct descendants.

You can also reduce the value of your pension pot by gifting money, after paying income tax, to beneficiaries before you die.

Regular gifts of surplus income can be immediately free of inheritance tax otherwise you must live more than seven years to avoid inheritance tax.

It is early days in terms of planning for the inheritance tax changes, but most commentators agree it will make sense to take more income from pensions and this will not be a bad thing.

The maths can be complex but if people don’t take income from their pension at the right time and in the right way they could be ‘tipping money down the drain’.

Put very simply, there is an opportunity cost of not taking income from your pension. Take a £100,000 pension pot and assume it could produce an income of £6,000 per annum.

If the income is delayed by one year that will be £6,000 not taken. Over five years it will be £30,000 given up.

In many cases, although the income taken in the future may be more, it will not be sufficiently high to compensate for the income given up.

This means that delaying taking income can result in a lower lifetime income.

Annuities are misunderstood because they are not ‘legalised theft’ by insurance companies, they are the optimum way to maximise lifetime income without risk.

Therefore, if income is to be taken from pensions, annuities should not be overlooked.

I can understand how charging inheritance tax on very large unused pension pots will result in more higher inheritance tax bills, but for the majority of people, with good retirement income advice, they should be able to both maximise their own lifetime income and maximise the amount they live to their children after accounting for all taxes.

Finally, in my experience, expectations change with age especially because people underestimate their life expectancy when they first retire.

Generally speaking, when people first retire they place a high priority on leaving an inheritance but as they get older they realise they might need their pension pots to fund their own retirement, especially if expensive care fees may be needed.

Adult children are usually better established financially by then too.