Investors savings (Image: Getty)
Savers are being warned not to slash pension contributions ahead of inheritance tax changes, as doing so could leave them tens of thousands of pounds worse off.
From April 6, 2027, Chancellor Rachel Reeves will bring direct contribution pension pots into people’s estates for inheritance tax (IHT) purposes.
Many deliberately built up pension wealth to reduce their exposure to IHT, but are now rethinking their strategy. However, experts say abandoning pensions altogether could be a costly mistake as they still offer huge benefits, including upfront tax relief.
Basic rate taxpayers get 20% tax relief on contributions, which increases every £80 they pay in to £100. Higher rate 40% taxpayers can claim another 20% back through their tax return, so each £100 costs them just £60. An additional rate 45%, taxpayers can claim even more.
Pension money then rolls up tax-free, with dividend income and share price growth added to both the contribution and the tax relief.
In addition, those with access to a company scheme will get employer contributions of at least 3% and sometimes more.
An employer on the median UK salary of £39,039 could build a pension pot of nearly £262,000 over 30 years, new figures from Murphy Wealth show.
This is based on the minimum 8% contribution to a workplace auto-enrolment scheme, plus an average total return of 6% a year after charges.
By contrast, saving the equivalent into an ISA could leave them with just under £131,000, just half as much.
There is no upfront tax relief on ISA contributions, although all growth and income can be withdrawn free of charge. By contrast, once the pension 25% tax-free lump has been taken, income tax may be due on any amount that exceeds the personal allowance of £12,570.
With the allowance frozen until 2031, it may eat up the vast majority of tax-free income, leaving your pension withdrawals completely exposed.
Adrian Murphy, chief executive of Murphy Wealth, said: “Even with the forthcoming changes to their inheritance tax status, pensions are still the best way of building wealth over the long term.”
He said tax relief and employer contributions make a huge difference over time. “It’s difficult for other savings vehicles to compete, as our figures demonstrate.”
He acknowledged the concern about IHT but urged savers not to overreact. “A lot of people have an eye on the implications of pensions being brought into estates, and rightly so. The change undoes years of financial advice in one fell swoop, but it shouldn’t stop you from aiming to build up as much wealth as you can.”
Instead, retirees may need to rethink how they draw income. “Pensions would have been the last place to look because they could be passed down to your family free of tax. But now, they might be the first port of call,” Murphy said.
Families should examine other ways of reducing their IHT liability to keep their estate below the threshold at which they have to start paying it. Options include gifting, setting up a trust, or taking out a whole-of-life insurance policy to cover the bill. Consider individual independent financial advice.
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