Should you save more into a pension? What the changes to IHT mean for you

Historically, saving into a pension has been seen as a smart investment strategy to reduce your tax liabilities.

Due to pensions being exempt from Inheritance Tax (IHT), they were seen as a viable way of ensuring that you or your family could benefit from them with little risk of being taxed.

In many instances, people would forgo pay rises and instead opt for bigger pension contributions that they could make use of later in life.

However, IHT is changing, and from April 2027, unspent pension pots will be considered part of your estate for IHT.

As this may confuse your tax planning, we are going to examine the impact of these changes and consider what you can do about it.

Why am I now at risk of Inheritance Tax?

The IHT threshold (known as the nil-rate band) is £325,000 per individual, but the threshold increases to £500,000 if you leave your home to a direct descendant, thanks to the additional £175,000 residence nil-rate band.

This allowance can be passed on to your spouse to create a potential £1,000,000 threshold before IHT is paid at a rate of 40 per cent on the estate.

Given that your property is likely to make up a sizeable portion of your wealth, and your assets may also be substantial, the addition of an unspent pension pot could tip your estate over the edge.

This will be especially true if you have been using your pension pot to reap greater financial reward from working while keeping your tax bill low, thanks to the tax benefits of saving into a pension fund from your regular income.

Does this mean I shouldn’t save for a pension?

A pension is still likely to serve as a decent wrapper for paying reduced tax on your earnings compared to receiving funds as a salary.

However, it impacts the considerations you must make regarding your estate as you approach the end of your life.

While your pension might be challenging to move, other assets could be offset as gifts, provided these are given seven years prior to your death.

Any gifts given seven years prior to your death are not considered for IHT, whereas those given closer to your death will be.

Valuing your assets and prioritising gifting the ones with higher value could be a smart way to reduce your overall estate and thus reduce your risk of IHT.

What is the best strategy going forward?

It is worth remembering that these changes do not come into force until April 2027.

Even then, there is little guarantee of what the future might hold and how rules and regulations might change going forward.

Successive Governments may redefine an estate in terms of IHT, so nothing is ever truly set in stone.

What is important is that you get ahead of the changes by considering smart tax planning as soon as possible.

Seeking advice from a trusted professional is the best way to stay ahead of the changes and ensure that your retirement strategy is kept up to date with evolving tax rules.

If you are concerned about how this change to the IHT rules may affect your retirement planning and estate, speak to our team today.