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For years, “spend your pension last” was the financial planning mantra recited by wealth managers. Following the Budget in October, this has changed to “spend your pension before Rachel Reeves does.”
Inheritance tax will be extended to unspent pension pots from 2027 — prompting the well-advised wealthy to have a radical rethink of their retirement plans. Whether retirees opt to take money out of pensions and spend it, gift it to the next generation or leave it where it is, it is set to be a “gold mine” for the Treasury, generating £40bn in additional taxes over the next two decades, according to former pensions minister Sir Steve Webb.
This will be music to the ears of whoever might be chancellor by the year 2030 (I bet it won’t be Reeves) when tax revenues from this change are predicted to accelerate. But could behavioural changes offer a near-term boost for the property market and the consumer economy?
Webb is well placed to calculate the potential upside. Now a partner at consultancy LCP, he has based his estimate on the huge number of final salary pensions that were transferred out of defined benefit schemes between 2015-2020, typically by men in their late 50s working for blue-chip companies.
The era of ultra-low interest rates ensured high transfer values, tempting over 100,000 retirees to trade the security of an income that would die with them for a more flexible investment pot they could pass to their heirs free of IHT (and in some cases, free of income tax) — until now.
Spouses and civil partners aside, from 2027 anyone inheriting a pension pot could have to pay IHT and income tax at their highest marginal rate. To avoid this “double taxation”, financial advisers and their clients are weighing up the merits of upping pension withdrawals. These would be subject to income tax, but prudent use of gifting allowances (including the so-called “seven year rule”) could lessen IHT liability, or remove it altogether.
Gifting property deposits to children or grandchildren will be the first thought for many. Last year, the bank of mum and dad spent £9.2bn supporting 335,000 house purchases in the UK, according to Legal & General, with almost half of buyers under 35 receiving family assistance. If this ratio rises as Reeves tweaks mortgage affordability for first-time buyers, it could boost property prices and stamp duty revenues.
David Hearne, a chartered financial planner at FPP, says the measures will reshape the great generational wealth transfer. Many of his clients are now considering making regular pension withdrawals (incurring income tax on the way out) and funding pension contributions for their adult children, who will receive tax relief and employer contributions on the way in.
He predicts equity release to extract value from the family home will be a popular tool. Money taken that way can be spent or gifted, with debts reducing the value of the estate and lessening the sting of IHT bills.
To encourage wealthy retirees to spend and enjoy their money, Hearne keeps a big reel of 40-per-cent-off stickers on his desk as a conversation starter. “Spending £20,000 on the trip of a lifetime could be seen as only costing £12,000 as the money won’t be subject to 40 per cent IHT when you die,” he says.
As advisers and their clients rejig plans, could this pulling forward of spending help to turbo-charge VAT receipts and boost the lacklustre UK economy?
Despite LCP’s punchy predictions, Paul Dales, chief UK economist at Capital Economics, has doubts. “It’s not a huge difference for the overall economy”, he says, “although it could be for individuals or their heirs.”
Much will come down to timing. If retirees pull more out of pension pots sooner than expected, this will reduce their spending power in later years. And while the wealthiest can spend (or gift) with confidence, the biggest worry for those less affluent is balancing investment risk against longevity risk.
Those in my own circle who netted tidy sums by transferring their defined benefit pension into a Sipp have had a nerve-racking week as DeepSeek roiled global stock markets.
Run down the pension too much, and they risk running out of money in retirement. Plus, they will have given up any spousal benefits in their defined benefit scheme and will need to provide enough for a surviving partner. This, and the lottery of care costs, could be a brake on spending and gifting.
Difficult choices lie ahead. But with more than half of all those retiring between now and 2060 forecast not to be saving anywhere near enough, these are nice problems to have.
Claer Barrett is the FT’s consumer editor and author of the FT’s Sort Your Financial Life Out newsletter series; claer.barrett@ft.com; Instagram and TikTok @ClaerB
claer.barrett@ft.com