2027 pension reforms - revising strategies for DC drawdown planning

gm0

I think we are due a conversation on DC pension planning in the new world of DC pensions inside estates from 2027.  Dust not fully settled.  Not the politics of it. Focus on strategies for the retiree adapting and optimise to the new rules - and what if anything at all - is new

Retirement planning prior art that still matters

1 Downsizing family house (for consumption, bridging early retirement, or gifting).

2 Gifting - PET, and gifting from regular income - bank of mum and dad

3 Buy a joint life 100% (or other %) RPI/CPI/3% annuity to taste - part or all of pension pot

4a Manage ongoing the size of projected residue (down) with advanced drawdown methods 

Variable income etc. Get that spent. Don't pay 40% income tax then have it as savings in estate to be taxed at 40% again. Get it gifted  Yet avoid running out. Plenty of headroom at 40% from 50k to 125k under self assessment. Which is now tax neutral. Or even slightly better than neutral if inside the allowance clawback zone on house + pension + savings.  

4b Tax band driven optimisation and simplification 

Just sticking to the limits of bands as apply to the individual - stepping around crude attempts at means testing access to whatever it is this week.  Let's skip the tax simplification vs opportunistic unfair complications discussion. You choose whether to step over thresholds when you organise pension income.  Fiscal drag may well change that for you anyway.  But still.

I am not saying that those 4 are all slam dunks.  They are topics needing consideration. e.g. 3 could be an excellent or terrible decision. Depends what happens UK and world - next decade or two.  Insufficient indexation on pensions impoverished pensioners in the 60s-70s.  Could again.  World disorder and a prolonged correction cycle could play havoc with invested drawdown alternative. Variations on sovereign default are not entirely off the table around Europe.  So considerations choices - consequences. And in my mind as so often the case "hedging" your bets.  Not all in.

Retirement prior art that's changed:

"Spend your pension last" idea is moribund - preferential asset disposal as IHT planning.  

Unwrapped is still first (because CGT). Extant S&S ISA, DC pension now broadly equivalent.  To family situation naturally.  With regulatory fiddling on both risk ever present.  A mixture seems appropriate.

What is new?

5) IHT bill and paying it - where one wasn't in general expected before.

People with a DC pension pot dying inconveniently could generate a meaningful IHT bill that wasn't part of their prior long term plans and needs promptly paying.  

Hopefully this can be done from the pension scheme as promised. How much flexibility we get for executors to flex scheme pays direct mechanism up or down with other IHT liability and other assets pension and not - is unclear to me. I fear the worst. Bureaucratic across schemes and inflexible.  But suggestive that consolidation to one pension provider possibly later in retirement (if not there already) is sensible tidying up).

6) whole of life insurance written in trust - still outside IHT as of now.

Having adjusted pension income up and pot down (sensibly to 3, 4a/b) via annuity purchase (removing capital) or varied in in drawdown to manage down residue.  If there is excess income premiums may be affordable.  Smaller estate. Exempt payment from the whole of life in trust at death.  Although the more flexible - PET and regular income gifting is available. Handing over the money that could be spent on premiums achieves the same transfer (with 7 year rule for PET and the anti-avoidance measures on income/expenditure on the other one).  And without the gambling on death date and further regulatory reforms during the long policy.  Frankly it would be odd if this remained and gifting was hamfistedly clamped incentivising more people into this particular corner.  And then sheep in that pen - it was attacked in its long flight with a new levy on existing stock. Insurance written in trust would appear to be a niche item still useful to some scenarios and with its own risk profile.

What is wrong? 
What are other strategies people now need to think about?

Bostonerimus1

Excellent review. I'm going through some of the same thinking right now

Bostonerimus1

gm0 said:

I think we are due a conversation on DC pension planning in the new world of DC pensions inside estates from 2027.  Dust not fully settled.  Not the politics of it. Focus on strategies for the retiree adapting and optimise to the new rules - and what if anything at all - is new

Retirement planning prior art that still matters

1 Downsizing family house (for consumption, bridging early retirement, or gifting).

Remember the allowance for leaving your home to immediate family

2 Gifting - PET, and gifting from regular income - bank of mum and dad

This is a good idea, but it takes careful planning and record keeping and you need to make sure you don't give away too much. It's a long term strategy

3 Buy a joint life 100% (or other %) RPI/CPI/3% annuity to taste - part or all of pension pot

This uses your capital and so the bairns will never get it....60% is better than 0%. It's useful as part of a retirement income strategy.

4a Manage ongoing the size of projected residue (down) with advanced drawdown methods 

Variable income etc. Get that spent. Don't pay 40% income tax then have it as savings in estate to be taxed at 40% again. Get it gifted  Yet avoid running out. Plenty of headroom at 40% from 50k to 125k under self assessment. Which is now tax neutral. Or even slightly better than neutral if inside the allowance clawback zone on house + pension + savings.  

I'd emphasize gifting to heirs and charitable giving rather than spending. The old Methodist/Socialist in me still views money as a route to dangerous temptations so after I'm comfortable I'd rather give it away than spending it.

4b Tax band driven optimisation and simplification 

Just sticking to the limits of bands as apply to the individual - stepping around crude attempts at means testing access to whatever it is this week.  Let's skip the tax simplification vs opportunistic unfair complications discussion. You choose whether to step over thresholds when you organise pension income.  Fiscal drag may well change that for you anyway.  But still.

I am not saying that those 4 are all slam dunks.  They are topics needing consideration. e.g. 3 could be an excellent or terrible decision. Depends what happens UK and world - next decade or two.  Insufficient indexation on pensions impoverished pensioners in the 60s-70s.  Could again.  World disorder and a prolonged correction cycle could play havoc with invested drawdown alternative. Variations on sovereign default are not entirely off the table around Europe.  So considerations choices - consequences. And in my mind as so often the case "hedging" your bets.  Not all in.

Retirement prior art that's changed:

"Spend your pension last" idea is moribund - preferential asset disposal as IHT planning.  

Unwrapped is still first (because CGT). Extant S&S ISA, DC pension now broadly equivalent.  To family situation naturally.  With regulatory fiddling on both risk ever present.  A mixture seems appropriate.

What is new?

Yes! The lack of crystal balls means that tax planning can be incredibly frustrating. Do a bit of everything and don't worry too much. When I feel my head exploding with the options and unknowns I just decide to do a few simple things to levels that seem sensible and then remind myself that I'm lucky to be worrying about IHT.

5) IHT bill and paying it - where one wasn't in general expected before.

People with a DC pension pot dying inconveniently could generate a meaningful IHT bill that wasn't part of their prior long term plans and needs promptly paying.  

Hopefully this can be done from the pension scheme as promised. How much flexibility we get for executors to flex scheme pays direct mechanism up or down with other IHT liability and other assets pension and not - is unclear to me. I fear the worst. Bureaucratic across schemes and inflexible.  But suggestive that consolidation to one pension provider possibly later in retirement (if not there already) is sensible tidying up).

The best we can do here is to have a will and a summary of all our assets including account numbers, passwords etc so that executors etc can easily find everything. Organizing your assets will be greatly appreciated. 

6) whole of life insurance written in trust - still outside IHT as of now.

Having adjusted pension income up and pot down (sensibly to 3, 4a/b) via annuity purchase (removing capital) or varied in in drawdown to manage down residue.  If there is excess income premiums may be affordable.  Smaller estate. Exempt payment from the whole of life in trust at death.  Although the more flexible - PET and regular income gifting is available. Handing over the money that could be spent on premiums achieves the same transfer (with 7 year rule for PET and the anti-avoidance measures on income/expenditure on the other one).  And without the gambling on death date and further regulatory reforms during the long policy.  Frankly it would be odd if this remained and gifting was hamfistedly clamped incentivising more people into this particular corner.  And then sheep in that pen - it was attacked in its long flight with a new levy on existing stock. Insurance written in trust would appear to be a niche item still useful to some scenarios and with its own risk profile.

What is wrong? 
What are other strategies people now need to think about?

I expect there to be a growth in life insurance for IHT tax planning and also a growth in it's mis-selling and some high fees charged. I note that this is last on your list and it would be the last strategy on my list too. The reforms to bring DC pensions under the estate for IHT purposes seems entirely sensible to me. I believe they avoided IHT previously because pensions used to be all DB and there was simply no pot to tax on transfer after death. So IHT on DC pensions is a good move, however, the tax free IHT allowance has been stagnant for a long time and should move up substantially...maybe 1 or 2 milion pounds plus the house allowance.

gm0

"however, the tax free IHT allowance has been stagnant for a long time and should move up substantially...maybe 1 or 2 milion pounds plus the house allowance."

Oink Oink. Flap Flap.

Triumph13

"The reforms to bring DC pensions under the estate for IHT purposes seems entirely sensible to me. I believe they avoided IHT previously because pensions used to be all DB and there was simply no pot to tax on transfer after death."
More to the point, there was a 55% tax charge on unspent DC funds at death until 2015.

I too think the moves are correct and inevitable, although a bit of extra nil band for them would not have gone amiss.

DRS1

@gm0 I know someone who speaks the way you write your posts.  I put it down to his having a brain that works faster than his mouth.  Some of us more pedestrian thinkers find it hard to follow.

cfw1994

“Retirement planning prior art that still matters”

Live your best life.
Do things that make you and your family happy.
If you now find the new rules mean you have too much money - & what a first world issue that is! -  spend it on experiences you and your loved ones can enjoy: create memories.

I know you are focussing on the finances, but sometimes I feel that people focus too much on that instead of the important things in life.  

When something went wrong (fiscally), I do remember my dad telling me (with a glint in his eye 😉) “it’s a good job it’s only money”.
He wasn’t wrong!

leosayer

gm0 said:

"however, the tax free IHT allowance has been stagnant for a long time and should move up substantially...maybe 1 or 2 milion pounds plus the house allowance."

Oink Oink. Flap Flap.

I did some back of a fag packet maths the other day which told me that a full-time auto-enrolled worker on minimum wage would have a pension far larger than the current IHT allowance well before they turn 60. 

Bostonerimus1

Triumph13 said:

"The reforms to bring DC pensions under the estate for IHT purposes seems entirely sensible to me. I believe they avoided IHT previously because pensions used to be all DB and there was simply no pot to tax on transfer after death."
More to the point, there was a 55% tax charge on unspent DC funds at death until 2015.

I too think the moves are correct and inevitable, although a bit of extra nil band for them would not have gone amiss.

Thanks for the education. That's interesting. With DC pensions coming under the IHT umbrella and without an increase in the nil tax allowance many more people will have to deal with IHT. That might be a windfall for the Treasury and might be seen as a "necessary evil" to help with services and the debt load, but it's an easy thing to spin politically and might not be a good move at the ballot box.

Bostonerimus1

leosayer said:

gm0 said:

"however, the tax free IHT allowance has been stagnant for a long time and should move up substantially...maybe 1 or 2 milion pounds plus the house allowance."

Oink Oink. Flap Flap.

I did some back of a fag packet maths the other day which told me that a full-time auto-enrolled worker on minimum wage would have a pension far larger than the current IHT allowance well before they turn 60. 

Yes, I have practical experience of 35 years of DC contributions compounding at an annual average of 9% and the numbers end up way higher than the current UK IHT allowance. IHT isn't an issue for me in the US as the nil band allowance is $14M for a single person and $28M for a married couple, but under UK rules there will be a large IHT bill.

JoeCrystal

leosayer said:

gm0 said:

"however, the tax free IHT allowance has been stagnant for a long time and should move up substantially...maybe 1 or 2 milion pounds plus the house allowance."

Oink Oink. Flap Flap.

I did some back of a fag packet maths the other day which told me that a full-time auto-enrolled worker on minimum wage would have a pension far larger than the current IHT allowance well before they turn 60. 

Hmm, I disagreed actually. Assume the employee is 22 years old, working 37.5 hours per week and earning £12.21 per hour, which translates to a salary of £23,809.50. And assuming the employer is average, which is the minimum auto-enrollment, they will contribute 3% & 5% from the employee, so the pension fund receives £117.13 per month in contributions. Thinking that pension fund returns kept pace with inflation at the bare minimum (aka, no return above inflation at all), it only added up to £53,411.28 pension fund in today's money. Of course, the assumption is that 1. Auto-enrollment remains the same, i.e., only applies to wages above £6,240. Always on minimum wage but kept up with inflation and 3. If the pension return is actually good enough, and lastly, the IHT allowance kept pace with inflation.

To see a pension pot reach above £325,000, the employee would have to hope for a return of 9% above inflation per year to reach £397,253. [Which may be unrealistic if it is sitting in a default fund. I only started my own pension scheme a few years before AE kicks in, and transferred it all in at a later date. Even then, I only saw 3% return per year since 2009, after accounting for inflation. So, how do you get that conclusion? What was the monthly contribution and the return, for example, to make it so much bigger than the current IHT allowance? 

EDIT: I had to update the figures since I accidentally used 40-hour weeks instead of 37.5-hour weeks when adding up the total.