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What to expect from the Budget on pensions and inheritance rules
As the Autumn Budget nears, Royal London’s Clare Moffat outlines what potential pension and inheritance tax changes could mean for savers.
With the Autumn Budget fast approaching, attention is turning once again to what changes the Chancellor might make to pensions and inheritance tax.
Speculation has been rife and this has led to people making rash decision. But it is essential to understand fully the implications of possible changes and the effects that pre-emptive decisions can have.
To explore what could be on the horizon, we spoke to Clare Moffat, a pensions and tax expert at Royal London, about the speculation and what savers and advisers should keep in mind.
Speculation starts earlier every year
According to Moffat, the annual discussion around pensions and tax begins sooner each year. “It feels like all of these conversations are starting earlier and earlier,” she says.
“[Financial] advisers are getting lots of these conversations as well. Their clients are phoning them up, they’re asking about different things because they’re seeing lots of stories in the press.”
She says pensions and tax are natural targets when the Treasury is looking for ways to raise revenue.
“When we think about pensions and especially things like pensions tax relief, for example, it costs a lot of money,” she explains.
“So you can see why these types of suggestions for tax freezing do come up.”
The complexity of changing tax relief
Among the recurring rumours before every Budget is the idea of reforming pension tax relief, such as introducing a flat rate.
Moffat says that while it sounds simple, the system is far too complicated for quick fixes.
“If it was all the same, if everybody operated in the same way and it was all relief at source, it would be fairly easy to work out a flat rate,” she says.
“The problem is that we have net pay schemes and some of the biggest are actually public sector pensions. It would take quite a lot of legislation to do that.”
She notes that the Government always weighs “political risk, complexity, and how much revenue something will bring in” when considering changes. “On the complexity level,” she says, “this is complex.”
A further issue is that many people do not understand how pension tax relief works. “People have said to me, ‘I pay tax on my pension,’” says Moffat.
“They really just don’t understand how it works. If you’re employed, there’s something coming from your employer, you’re paying in some, but also you’re getting that top-up from the Government.”
For younger savers, she adds, pensions can be misunderstood.
“If you’re just in a workplace scheme and maybe at the start of your career, then maybe you don’t see the benefits of a pension. You see it as a cost coming off every month,” she says.
Understanding tax-free cash
Another area of speculation concerns the 25% tax-free cash that people can take from their pensions. Moffat says she has seen increased interest from customers and advisers about whether this could be restricted or removed.
“We had similar last year,” she says. “People got quite worried about this and started taking money out of their pensions earlier than they would have.”
Although she acknowledges the concern, Moffat thinks significant changes are unlikely. “From a political risk point of view, tax-free cash is the most understood and one of the most popular things that’s known about pensions,” she says. “People have a plan for it way in advance.”
She adds that the practical and financial incentives for cutting it are limited. “Reducing it isn’t as easy as it seems at first,” she says. “It probably wouldn’t bring much revenue in the short term.”
Moffat’s bigger concern is that some people might make premature decisions based on rumours.
“People are getting in touch with their pension company, saying they’d like their tax-free cash out, but they perhaps don’t have a plan for that money,” she says.
“When money is really easily accessible, it’s a bit easier to take it out and spend it.”
How people use their pension cash
Most people, Moffat says, use their tax-free cash for sensible reasons.
“They might use it to pay off debts, mortgage debts, or gift it to children to help them with a deposit to get onto the property ladder,” she explains.
“People use it for big purchases, doing up houses, big holidays, buying a car, maybe not a Lamborghini but you know, a car for retirement.”
She adds that some people take smaller, regular withdrawals rather than a lump sum, especially if they are easing into retirement.
“We are seeing more people deciding that they want to reduce their hours but not stop working,” she says. “They’re taking their tax-free cash in monthly amounts, for example, until they’ve used it up.”
However, she cautions that overdoing it can have long-term effects. “If you take out too much too young, that’s going to impact how much you have in your pension later,” she says.
“Sitting down with an adviser is crucial because they can explain how that might affect your standard of living later on.”
Inheritance tax and gifting rules
Inheritance tax is another area where speculation is rife. Moffat says there has been talk of simplifying or consolidating the current range of exemptions and allowances.
“There’s been speculation that there could just be one overall gifting allowance, perhaps a lifetime or annual amount,” she says.
“We have all of these different rules about reliefs and exemptions, and it is complicated.”
The ‘normal expenditure from income’ exemption, she adds, is a particular focus for financial advisers at the moment.
“It was very underused in the past, but because of changes in pensions it’s becoming a bit more popular,” she says. “There’s a concern that it could disappear.”
Some of the gifting rules, she argues, are simply outdated.
“We’ve had inheritance tax since 1984, and some of the amounts have been the same for a very long time,” she says.
“The annual gifting allowance of £3,000, the £250 that you can give to as many people as you want – they don’t really match inflation.”
She also points out that inheritance tax rules will begin to apply to pensions from 2027. “The draft legislation is complex,” she says.
“We still don’t have a lot of the answers to some of the questions that we’ve got.”
The importance of advice
For Moffat, the key message amid all the rumours is to avoid panic and seek good advice.
“Advisers have to advise on what the law is right now,” she says. “You can have one eye on the future, but when we don’t even have complete legislation or regulations, it’s really hard.”
She notes that speculation can sometimes prompt people to act rashly. “In the past when we thought something like the annual allowance was going to decrease, people would put more into their pensions, which was no bad thing,” she says.
“But this is the opposite – people might be making decisions based on incomplete facts, and that could have an impact on their future.”
Her takeaway is simple: “Financial advice is the gold standard. It’s not just about pensions and tax planning. It’s about having someone to help you plan for the rest of your life.”
DISCLAIMER
This article is produced for general informational purposes only. It should not be construed as investment, legal, tax, mortgage or other forms of financial advice.
If in any doubt about the themes expressed, consider consulting with a regulated financial professional for your own personal situation.
Past performance is no guarantee of future results. Investments can go down as well as up and you may get back less than you started with.
Investments are speculative and can be affected by volatility. Never invest more than you can afford to lose. For more information visit www.fca.org.uk/investsmart
