The recent budget announcement created a fair degree of anticipation, a sizeable budget shortfall and a manifesto that ruled out the three main sources of tax revenue (Income Tax, NICs and VAT) meant the chancellor was forced to look elsewhere to fill the financial gap. Speculation about potential changes to the tax-free pension lump sum led to a surge in people taking tax-free cash, only for this to be ruled out at the eleventh hour. If professional advice had been sought, a measured approach to this decision will no doubt have been carried out, but many who didn’t fully understand the considerations, and how this related to their individual circumstances, may well now be regretting the decision, having unnecessarily brought their tax-free pot into the taxable domain.

On reflection, what transpired in the budget announcement appeared to be very much ‘more of the same’. ‘How can we raise taxes without raising taxes?’ Well, the preferred course for successive chancellors has been simply to freeze tax thresholds even further, and this time was no different. However, in the persistent inflationary environment in which we preside, I fear the rather benignly termed ‘fiscal drag’ will really start to bite, pulling more and more of the working population into higher rate tax thresholds and now even more state pensioners are having to file tax returns.

Perhaps of more interest is what wasn’t mentioned in the budget. The current inheritance tax (IHT) framework went largely unchanged, the Nil Rate Band, the threshold at which IHT becomes payable, remains at £325,000, set all the way back in 2009 and now frozen until at least 2031. IHT receipts are projected to reach a record £9.1 billion for the 2025/26 tax year, a trend that is set to continue.

And this leads us to the real hot topic, pensions. With all the noise around the 2025 budget announcement, let’s not lose sight of the big reveal in last year’s announcement; as of 6 April 2027, pension funds will be brought back into the estate for IHT purposes, and as this date comes into sight, the real-life implications of this policy decision are starting to sink in. Will this affect me? I hear you say. Well, quite possibly!

For those approaching the IHT limit, the advent of accumulated pension funds being brought into the calculation means IHT should now be firmly part of the financial planning conversation, and if you were already ‘in the zone’, there may now be further aspects to consider. For example, with the Resident Nil Rate Band being tapered away for estates in excess of £2m, the revised calculation including pension assets may result in the loss of this additional IHT relief.

For those already carrying out longer-term Inheritance tax mitigation exercises, to date, pension funds may well have served as a rather neat and tidy solution, a way of passing down funds to the next generation free of tax via a death benefit nomination. Now, suddenly, these strategies will need to be reviewed and in many cases are being flipped on their head, indeed, understanding that in the event of death post age 75, the combination of IHT and income tax may result in up to 85% of the fund being taxed certainly focuses the mind.

As a result, ‘gifting out of surplus income’ is fast becoming a popular talking point. Where appropriate, pension drawdown income could be forwarded on to the next generation, and so long as these gifts follow a habitual pattern of giving and mean you can still maintain your usual standard of living, these gifts may be deemed to be automatically outside of the estate for IHT purposes. A cautionary note, however, the exemption is not automatic and is typically claimed by your executors after your death and so maintaining the necessary record-keeping during your lifetime is crucial for your executors to successfully prove the claim to HMRC.

On this note, a thought should also be spared for the Personal Representatives, the executors of your estate, who are now faced with the challenge of collating all the necessary pension fund information before probate can be granted. Of course, if you’ve had some professional advice along the way, your position may be easily identifiable, but for those who never got round to reviewing a proliferation of smaller pots from previous employ, this could prove to be an administrative nightmare. Another reason for a pension consolidation review if you have not already done so!

In summary, pension funds are once again to be viewed as source of retirement income, as originally intended, and so it’s important to understand how this fits into the overall picture. Death benefit nominations, income strategies, consolidation, tax free cash, to name but a few. Action may be required and the value of professional advice has never been clearer.

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The content of this article is for information only and does not constitute formal financial advice. This material is for general information only and does not constitute investment, tax, legal or other forms of advice.

 References to legislation and tax is based on our understanding of United Kingdom law and HM Revenue & Customs practice at the date of publication. These may be subject to change in the future. Tax rates and reliefs may be altered. The value of tax reliefs to the investor depends on their financial circumstances. No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of these comments.

 You should not rely on this information to make, or refrain from making any decisions. Always obtain independent, professional advice for your own particular situation.

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