74: Pensions are Changing - What the New Inheritance Tax Rules Mean For You

[Music] Hello and welcome to the latest Retire Well Episode when we map you as always I'm joined by Joe. In today's episode we're going to be thinking about how people weigh up that objective of pensions being an income producing tool but also have a half an eye on estate planning and inheritance tax. Before we jump into that who are we we're well-throwed advice we're a chartered financial advice firm based up in the northeast of England and we help clients nationally. Yeah so again before we jump into the topic proper we do now have a live Q&A scheduled on the 24th of June at 530. There'll be a link in this description to register below and feel free to send in your questions in our funds. But Matthew, pension and estate planning how are we going to get everything into a 3035 episode? I don't know it's it's one of the the biggest sort of areas in financial planning. I feel like it's just getting bigger to be honest from from a planning perspective and thanks to the government and and and recent budgets. But why are we chatting through it today? I mean for years pensions essentially have been a pretty lovely estate planning tool. We sometimes refer to it as Feele first in last out the first thing you should be contributing to when you get your first job and the last out because previously if you were to die before 75 you'd be able to take everything out tax-free, go to your beneficiaries tax-free, not problem, no inheritance tax paid. But recently the government have made some changes at Collinth Force next year which means those pensions are going to be pulled inside the estate for estate planning purposes and potentially subject to inheritance tax. Yeah so why why are we talking about today? Well I think with a lot of our existing clients and with a lot of new inquiries it is that not conflictive objectives but it's that idea of going I've now got half an hour in the future so as the future gets closer the rules evolve we're also clearer with the planning strategies and in a real point of view you know this time next year the pension value from a defined contribution pension will be in someone's estate for inheritance tax. So as opposed to today thinking about how's goods cash and then say how are we looking against those inheritance tax thresholds from next April it'll be the same sort of equation but with potentially you know a large pension could push someone over into higher IHT. Yeah and before I almost get into the weeds on on how we plan for it I want to just quickly as quickly as possible run through sort of what what pension rules look like today compared to what they'll be looking like from from 2027. Yeah so at the moment pretty much the only thing you need to know about is the the rule change at 875 so if you were to die pre 75 before you 75th birthday all of your pensions outside of your estate it can pass down to your beneficiaries and they can either take it as drawdown in unity or lump sum and the vast majority of people will receive that tax free. There is a lump sum in death benefit allowance of 1 million 73 thousand 100 but most people will fall fall in line with that and I suppose the planning points of that create is that you can pass it down nice efficiently you don't necessarily want to draw from your pension and that's what a lot of people have been doing for a number of years after 75 it still passes to your beneficiaries tax free so no inheritance tax to pay but the beneficiaries will essentially pay tax at their marginal rate when they withdraw it so say you've got a hundred thousand pound pension goes down to the beneficiaries if they leave it there complete tax free no problem if they draw from it they'll just pay it income taxes they would their salary and an important one there whenever it passes down it essentially resets that that preimposed 75 so if you were to die at 76 it would pass down if your beneficiary wants to draw it out then it would be taxable but if they were to die pre 75 then the next person can draw it on down completely tax free so nice and simple yeah currently I mean it's getting a little bit a little bit more complex in 2020 so yeah and I think it's that you know the preimposed age 75 point is the income tax point and then the inheritance tax potentially again currently there's no inheritance tax on the pension and then this is the big change in the rules where some people feel that it could be you know being hard change to say if I have a normal life expectancy and I pass away at 86 my beneficiaries might be then taxed at their marginal rate and if I've already used my inheritance tax sort of bands with other assets you know there could be a 40% tax charge as well which is is almost prompting the likes of this episode because of that philo analogy being questioned in that scenario to potentially say okay is it now the last out or should I be saying I don't want to be holding all this towards death should I be doing something different and I think that's the starting point of the exercise yeah and an important point to sort of make here that that preimposed 75 rules still exists that's not changing yeah the only thing that is changing and it sounds really simple as that pensions are coming into the estate the problem is it creates a few more intricacies in how you might want to plan for it the big example which is a problem that's been highlighted quite a lot is if you die after 75 and you've got an inheritance tax liability you might pay 40% inheritance tax to pass it down to your children and then if they're a higher or an additional rate they'll pay 40 or 45% tax on top of the 40% tax that they've already paid and it's a pretty large tax liability there so I mean we'll get on to it there's plenty of ways to plan plan away from it and but I just thought for a second I'd outline potentially the the reasons why you might want to might want to not nominate your friends to be your executives if you actually like them so I mean the the probate process at the moment is still relatively simple yes it can take some time you need to make sure that you've got all your accounts right and but this pension rule in 2027 is going to change it and essentially there's maybe sort of a ten-step process that executives need to do and that the key thing is that they need to contact all pension providers separately get the values on death then look at that in line with the rest of the estate and then go back to the pension providers and let them know how much inheritance tax they have to pay if any so I don't know if anyone has sort of tried to claim death benefits from a pension in current rules it can take quite a while I imagine it's going to take even even longer in the future yeah and I think as we as we almost go through this episode we'll be almost bolting on but think about that I'll think about that I think it's it's useful to say at this point it's still important to have the death benefit nomination with your pension and that doesn't change even though it falls into your state which might then now be looking at your will and looking at your state those two things are separate because pensions are death benefits are technically in trust so you still want to have your nomination and you still want to have the flexibility of that nomination and we found in general if you don't nominate someone to potentially benefit you can't then change percentages and change how things are actually allocated so that's still a really key plan and opportunity but to go back to your point there about the complexity and the change I think you exactly right we heard from a pension technical specialist recently who almost said you know if you've ever been asked by a friend to be an executor of their will now might be a reason to go back to them and say I'd rather not act he was obviously joking but it comes from a sensible point of view of what you know how straightforward are you leaving your affairs and are you helping someone like your executors to have the least administration burden possible when we know that this this is going to be a transitional period of more time spent or pension providers getting used to the rule change or how do they deal with the requests so there's going to be some friction for sure in in the next couple of years yeah and I think they'll they'll need to be more guidance for for general people that are being being executors I mean also not even just executors solicitors that are dealing with this at the moment might not fully understand the intricacies of a pension and at the moment would be the easiest way to sort of go through a probating pain inheritance tax bill would be to sell the asset if you do that in there sort of the the instance of a pension you've paid in inheritance tax you've sold it there's going to be almost that double bubble taxation to get through so lots of things to think about and just an example at the moment you don't have an inheritance tax liability you're right on that million pound threshold so no rate band and residency no rate band between a couple and you were to have a four hundred thousand pound pension pot at the moment knowing her to the tax from 2027 you've got a hundred and sixty thousand pound inheritance tax liability on day one similarly if you have something that pushes you above the two million pound threshold where you start to lose your residency no rate band it's actually going to be a high marginal rate of tax so there's plenty of stuff to think about and lots of different ways to fix it and there's not necessarily a right answer but the first in last out might still work dependent on on new scenario and I think for most people it really depends about what stage you're in in your retirement yeah I think we've certainly had a number of inquiries recently who have been focused on the estate plan in the element of the pensions but they might not even be in retirement yet and I think the first thing I say to them is well let's not you know jump ahead to killing you off a new iHT let's start with the what income you're looking for what does the next chapter look like and how do we go through that journey and then what might your iHT position look like in 2030 years I think there's certainly it's easy for this point to be a cael clwawn Baron Sac Brau'r Feelbred anonsu'r apdito deilol Onceir mewn, ond gwneud maloraf o ddeast i dewn hy لmy wykorfrânioedd, lle fel 10 👏www, neuulio drwy… Takiaw wr Contact pediatriciadiddi sicrhau vaedigell o passar, a am gyda ddim yn ac graddolion feitario'n'm am wedi diguriau we班ol, a am gyde dell ddysull Pr��ria Hus Then packaging a roarnio Lt diagramع vacchon a ti beth y cwst. A peb pir introduce wir panoriaeth yd Ond y pwgrwy ydy creiku a flüchtig. Mw'r panor a'r gyda ddim yn fwy'r panoraf o ddim yn panoraf o ddim yn gwaith, a'r gwaith ar gyda ddim yn fwy'r gwaith ar gyda ddim yn ymwch yw'r cymrydor. Gw'r ydych yn fwy'r cymrydor gyda ddim yn fwy'r cymrydor, a'r cymrydor, ar gyda ddim yn fwy'r cymrydor, a'r cymrydor gyda ddim yn fwy'r cymrydor, a a'r cymrydor, yn fwy'r cymrydor, a a'r cymrydor, a a'r cymrydor, Mae o dragollio nhw Welach could Director of the Yn yw'n ni weldael. Mae'r ysgwch i'n ni weldael. to your marginal rate and you've got a pretty large pension. If you wanted to make large gifts into trust that we'd usually look at for a state planning, that could be a 4E, 45% tax liability. And then you go, do we pay 40% now to save 40% in the future? So I think again, that might be a way where you can actually let's look at some sort of insurance so that we don't have to do everything now and we can almost spread it out over a number of different years. - Yeah, I spoke to a potential new client through the podcast recently and they were aligned with some of the things we've said in the past about the day with zero mentality. I know most running down assets, but equally they've got quite considerable property and one of my early questions was, so when in the journey could you see yourself downsizing or selling your rental properties? And the answer came up quite clearly of a, oh no, I don't think we'd want to. And then in my head it's almost that bit of, so you'll never die with zero because you were already locking that fixed asset. So again, that's not a problem because it's someone's objective desire. It's just, are they then aware what it does to the next bit of their plan, which is where we've talked about the insurance element. So I think that's definitely, it's all of everything we do in financial planning. It's like understanding the problem, the objective, and almost go and watch the proportion at way to solve it. And I think that's really clear in this bit. One of the next bits that we'll talk about is trusts. And again, trusts at that point when you almost go, we know that we've got enough to protect ourselves, we've got enough flexibility, and we're now willing to physically carve out money to go down the generation. - Yeah, and trusts are for the most part, with most trusts, that more permanent step, where you're gifting something, you've made that decision, you might be either later in retirement or no, you've got enough guaranteed income, you've got enough assets outside of what you're gifting in the trust to sustain for the rest of your life. One trust that might actually work if you don't do that is something like a loan trust, where instead of gifting it, you're completely giving up your loaning a certain amount, say £100,000 into the trust, and you can still have access to the capital back. So if you want sort of access to capital, but do a little bit of a state planning, that could be something that works, and the way that that benefits your estate is any growth on that money is within the trust, that the loan obviously would be pulled back into your state from heritance stocks. - Yeah, and I think crucially as well, you've got the option to write off that loan in the future, if you then decide actually, and I thought I might need some of that capital back, I don't, you could write that off and start the seven year clock on that element of it. So if someone said, I've won the Euro-Millions tomorrow, I've got all the money in the world already, I'm already quite secure, so this is almost a bonus, I want to start off with some trust planning, they might say, I'm gonna put £325,000 into a trust, and that's today's planning, I might also loan £325,000 into a trust, which is then the growth is gonna be outside of my state, and then crucially in seven years' time, when that first gift might then drop out of their calculations, and they're thinking about gifting, they might then say, I've now decided I can write off the loan, and there's another permanent gift of that amount, and that can be a really good way to structure the planning. So I think, you know, trusts are a really, really good tool, again, in the same way that I think pension still add a lot of value, trust still add a lot of value, it's just again, understanding, going back to the objectives, going back to the priorities, if you always say, don't do a trust because your friends don't want, don't take a make a pension contribution, or pension was raw because that's how someone else dealt with their solutions. You know, it's very personal, it's very tailored, and that's where sort of holistic financial advice can add a lot of value. Yeah, and then after that, those trust gifts interest, as I said, can take seven years to fix it, ensure it might make sense. There are a couple more immediate ways to sort of get stuff out of your state, actually probably three, and I'm this kind of one, because we talk about it so often. One's gifts out of normal income, that's essentially outside of your state on day one, you need a really good record of it, and pensions are a great way to create that income to gift, and maybe we'll touch on that again towards the end. The other two is something like a discounted gift trust, or potentially using business relief, which is a benefit that you get if you invest in business qualifying assets. But the discounted gift trust to start, essentially you're making a gift into trust, you're wanting a regular income back out of that trust, and they essentially discount the cost of that regular income back to yourself, as outside of the state and the gift generally. Again, that's a pretty permanent solution. The discounted gift trust, it's not something that you can necessarily change. Business relief, you can, and Matthew, maybe you want to run through that. Yeah, just touch on the discounted gift trust first. It's almost similar to our last episode with the annuity, where you're almost going, "I want to have a guaranteed source." It's not guaranteed in the sense of there's investment risk on the actual money into trust, but you can't change the physical income that's being paid out of the trust. So therefore you're saying, "I'm carving out some income to come back, and then the rest of the money I'm allowing to grow interest outside of my state." Crucially, the amount that you can put in is discounted by the expected return of capital. So therefore you can put more in than your nail rate band, the 325, immediately without any potential tax. Again, we're getting into the weeds a little bit, but it can be a really efficient way to do it. On the business relief, it's almost saying, "We're going to invest in higher risk companies that benefit from the relief because of the extra start-ups and the risk taken, and they fall out of your state after two years, rather than that seven-year clock." So if we're almost thinking about different strands and different ways to solve a potential problem, the two-year clock is much more efficient than the seven-year clock, but what are you doing with that? You're taking on more risk and more of a challenge. So you've got to be comfortable that either your assets are enough to allow for the fluctuations, or that you are a speculative individual and you're willing to do that risk. Yeah, and those business relief investments do still have accessibility. You can withdraw them if and then you want to. However, the actual liquidity of them because the smaller companies might be slightly limited, and as soon as you take it out, then you lose the inheritance tax relief on them. The other one I mentioned there of gifts out of normal expenditure, again, I think is a really interesting one. It's a good one, one of the first things that we look at, if you've got access income either spend it or gift it, it makes sense. But I think it can actually solve some of the problem around if you've got no tax-free cash left in your pension, you could then, "Okay, let's pay 20% tax to create more income that allow us to gift." Then instead of gifting it directly or gifting it to a trust, you could potentially make a third-party pension contribution into your dependence on children's pensions, and then they essentially get the tax relief down here. So, almost getting around it in a bit of a clever way and ensure that you're not losing all of the tax relief from the family. Yes, you'll pay it, but the family might kind of fit. Yeah, I think tax is that emotional point that someone says, "I've worked hard, I've built up money, and then suddenly the idea of going, the lights are flashing, or there's more tax, there's more tax." But from that point of view, I think you're spot on. I think if you go, there's potentially 20% tax to be paid there, or 40% tax to be paid there on taking more income, if your children could benefit from tax relief at 20% or even 40%, or even 45%, again, you go, that's actually just equalising and you've got the asset transfer. So, we don't often have that joined up thinking where someone comes in and says, "Will you also think about my son being this or my daughter being that or my grandkids potentially saving for them?" But I do think, at the estate planning point, it's a really good way of saying, "We're not just thinking about you. We're thinking about the cascading of wealth." I had a recent client review where, you know, Mum and Dad are well off, but don't necessarily live the lifestyle. They're quite conservative, and they say, you know, with their spending, they say, "You know, we have its abroad us here. We do what we want, and we really enjoy it." So then we say, "Okay, whether you're one son, he's going to get all of this worldly wealth going to him, which is fighting for their almost objectives and their plans." But actually, in talking about his new job, he's suddenly a really higher-inner, he's suddenly mortgage-free, he's suddenly investing, he's got a really good pension, you actually go in your potentially limiting your spending or your opportunity to give him as much as possible, and actually he's already doing a really good job himself. So, you know, two options, I'd be saying there, again, going back to what we've told about spending more yourself, but potentially plan more for the grandkids or trying already. Don't give him more of a problem when he might get from himself, trying to cascade the family wealth to the generation below and give them a leg up, perhaps. Yeah, and that is why it's really important to have this conversation either with your parents, or with children, independent, and sort of where you're at, and make sure that they know where you sit, because yes, as we said, number one usually is that retirement and income spend, but secondary, most people know how to look in that estate planning piece and they might be planning wrong if they don't quite understand your situation if you were to receive them or vice versa if people are saving to give them the energy fat and that sort of thing. Yeah and I think on the other side of that sometimes people say I want to gift but equally my kids aren't quite at a point when I can trust them with a significant amount of money or you know what about people worrying about bankruptcy or divorce in the future. Again I think that's the bit that the trust especially can add value because you could be putting the money in there to allocate to them but it doesn't have to physically go to them yet or you can have loans from that trust that if there was a future bankruptcy or divorce the loan puts his hand up and says actually the family trust need to get back that 50 grand or that 100 grand and that would then be outside of the likes of divorce procedure. So again we're getting we're getting into the weeds of the logistics but actually I think what we're trying to really highlight today is a change in the rules does need to be a change in the mentality but it's also actually really just looking at the existing options and seeing when and how they could complement your financial planning. Yeah I think it doesn't necessarily even have to be a change to the strategy now as you said that it's just about the mentality and getting an awareness of the new rules because you're currently strategy of spending your pension down might get you to where you where you want to be. So I'm pretty happy to sort of round that bit up there I think it is about that sort of back to why why are we doing this and in terms of a listener's question Matthew this is one that we get pretty pretty often and it's around that sort of gift out of normal expenditure or gift out of regular income. How do you actually claim that do you claim it on day one? What's the crack that? Yeah so it's really it's claimed on death by in your state essentially so there's a form you know part of the probate forms has that bit to say you know what's been gifted in the last seven years and almost by doing that you need to have records to say okay well there might have been some gifts but it might have been from service income so what we often do with clients is we give them a document which is what do I own and where I keep it and if anyone's watching today you know leave a comment or drop us an email and we'll happily share that with you and that has a section on it to say okay you know in the last you know five tax years you know what was my income what was my expenditure what therefore was the surplus and what have I then gifted and it's almost just carving out how that's worked. The logical next question is what counts as income because we've got to be careful not to be gifted in capital do you want to sort of work through that a little bit? Yeah so I mean in the main if you're retired it's in the bulk it's going to be your pension in the same way that if you're working it's it's going to be your salary and I suppose a funny one on that one is maybe people don't necessarily think of tax recush within a pension as income and this is where you have to be a little bit careful if you were to take your tax recush or even actually anything from your pension as lump sums say 50,000 at the start of the tax year and then you were to gift it because that's what you see is your income. Hid you might not take the view of that being income one of the sort of best practice things that we've been looking at with regular income is make sure that it's paid out on a monthly basis be it the tax recush or the taxable income if it's on a monthly basis there's a reasonable argument to be made there's too h-pati. The pattern of it. Yeah the pattern of income and similarly with the gifting again if that can be on a regular basis a monthly basis as opposed to a lump sum at the end of the tax year that's much more likely to be considered as income than a lump sum so I think that's a good start with with pensions and how you how you define it. Yeah and I think people often say you know for example my iso income is that income I think that's one you've got to be careful on because if you've got a investment which is paying out a dividend you know paying out an income that can be classed but actually if your isofund were accumulating wealth and then you were choosing to withdraw capital and you were treating it as income yourself again HMRC might then say that doesn't doesn't fit the rules and you've actually taken capital there rather than income. And it can good something as silly as the type of units that you use for an investment income units versus accumulation units most people won't necessarily know the difference and to go on as most people probably use accumulation units and that's essentially when you are paid something it reinvest it immediately as opposed to an income that pays out to yourself. I think to be honest with all of this you want to be taking advice here you want to be discussing it with a financial planner first I think a solicitor may need to be involved and even accountant as well it's making sure that you get it right I think with with the state planning the mistakes that you can make can be bigger because there's a larger value involved it's worth having someone there to make sure that A you've got the plan on day one but be for ourselves we do in the main a lot of ongoing planning and making sure that when stuff like these legislative changes happen that you're adjusting the plan in the right way and you're not sort of making some some missteps that might cost you a decent amount. Definitely and I think having that financial planner relationship also means that you've got the blueprint that set out and therefore example if something happens to one of the couple they might be in the driving force behind the plan you don't leave there a spouse going oh we started a plan I'm not sure what I'm implementing it's all a bit messy and then you could accidentally you know everything could unravel whereas having a blueprint is almost to say as someone gets older and maybe less focused on the the detail of the finances there's still that bible the blueprint where the professional connections can help ensure that everything works through and then because what you don't want is you don't want an argument you don't want your beneficiaries to have to argue with HMRC no you know mum and dad were telling me it was a gift out of service income they were doing this always the evidence I don't know you know the more we've done that through the journey it makes life easier. You also don't want them to do the wrong thing as well because a lot of this is state planning yes you need to plan in a certain way but equally they need to take the income or take the capital of the pensions in a certain way for the plan to work as planned so if you would deal if brilliant planning and then we went through all of the 45% tax payer there's there's an on out the window which you were going to pay anyway so yeah having those intergenerational relationships and conversations are really really important when it comes to a state planning I think that's probably a good good place to end so thank you very much for watching we now have our sort of month of you newsletter every first Tuesday of every month and a new episode obviously weekly on Tuesdays and please remember to sign up for that live Q&A on the 24th of June that the registration link will be below if you're watching on YouTube please subscribe and spot a five leave us a rating help to get the podcast out there and we look forward to seeing you again next episode