Given the scale and impact of the Chancellor’s October Budget, there’s been a raft of challenges to it, most notably from farmers and from businesses impacted by changes to national insurance contributions.

The fact there’s been a negative response to the announcement that inheritance tax (IHT) will be imposed on pension assets from April 2027 is not surprising.

However, given the government’s firm stance post Budget, this rule looks set to stay, and the industry needs to start thinking through its implications now.

Advisers should consider the implications across their client base and prioritise the clients most likely to be affected - the very wealthy, those who are unmarried, or who may die early.

Following the experience of the previous government’s sudden removal of the lifetime allowance, this government has allowed time to plan for what is hopefully a smooth transition in rules.

But the change has thrown up many questions and while we wait for the detail, some planning can start now based on what is known.

Most importantly, this new IHT rule on pensions should not get in the way of delivering the best retirement income advice for good outcomes.

Working out the clients who may be impacted the most

Good outcomes, where clients reach a healthy retirement with enough money to do what they want to do, have to be the priority for retirement income advice.

The new IHT rule therefore is unlikely to matter much for clients with moderate wealth, who live a long and happy retirement into their nineties, as most of their pension pot will be used for income, or potentially for care needs. And for married clients who die early, the savings will likely be used by their spouse or civil partner before it ever becomes liable for IHT.

For very wealthy clients, however, who’ve not been taking an income from their pension and plan to pass it on, there are decisions to be made about gifting, or putting some money in trust.

One other area of concern is if the client and their spouse or civil partner both die early. It’s a risk but it’s one that shouldn’t detract from the core planning priority to fund retirement income.

As it’s only spouses or civil partners who won’t pay IHT on transfer of their partner’s pension assets, those clients who are single or who are cohabiting with a partner may be significantly impacted by the tax change. If the government is, as it says, so keen to promote equality and fairness, it may want to look at how to protect those who may be vulnerable dependents, or in long-term, cohabiting relationships.

Addressing the advice gap and the complexity of estate planning

Even before the October Budget, there was a steady rise in demand for advice.

Now, with this IHT announcement, there’s a risk that consumers with modest pension pots, unlikely to be impacted, may worry about a potential tax bill facing their beneficiaries if they die early. They may rush to gift money or spend it, leaving them with less to live on in later life, or take money out without gifting it, so not helping with IHT planning.

Estate planning is a complex area and it’s vital that consumers know where to seek suitable advice to help them avoid such risks. It’s timely that, as part of its ongoing Advice Guidance Boundary Review, the FCA has confirmed plans to publish an industry consultation with proposals to provide targeted support for pension savers.

There’s also been early speculation that there may be a wholesale shift back to annuities. The rule may slightly reduce drawdown’s attraction, but given the need for income in retirement, IHT should be a secondary issue for most.

The major benefit of drawdown is its flexibility to meet changing needs over time and to keep options open. For many, the need to cover the retirement income smile is real, where income needs start high, drop in later life, then rise again when people may need assistance with care.

One client segment where I can see annuities being used more is the very wealthy, where buying an annuity in later life could give them certainty of income to cover their needs, allowing them to gift the rest of their wealth.

I’ve also seen a strong argument that part of an individual’s pension savings should be protected from IHT, to provide for care in later life. It may encourage people not to run down funds too early to avoid the tax but given the lack of any government progress to properly address social care, this proposal looks unlikely.

Don’t let the estate planning tail wag the retirement income dog

The fact remains that pensions are still, for the majority, the most tax efficient way of saving for retirement with favourable tax relief on contributions and investment growth. That hasn’t changed.

However, given a much higher likelihood of an IHT bill for some, what will change is earlier engagement on estate planning. More people will want to have a discussion with an adviser about how they take their retirement savings and the options and tax allowances available.

What’s crucial is that advisers don’t allow the estate planning ‘tail’ to wag the retirement income ‘dog’, instead focusing on where this change matters to continue to deliver good outcomes for clients.

To see more of Alastair Black’s insights, go here and for more insights from our Techzone team, go here.

This blog is based upon abrdn’s understanding of UK law and HM Revenue & Customs practice in the UK as at December 2024.

Tax and legislation are likely to change. Tax treatment depends on individual circumstances.

The value of investments can go down as well as up and your clients could get back less than they paid in.

The views expressed in this blog should not be regarded as financial advice.