For many widowed clients, estate planning has long followed a relatively straightforward approach. If they didn’t need their pension to fund retirement, they could simply leave it invested and pass it on to the next generation, safe in the knowledge that it would usually sit outside their estate for inheritance tax purposes. That long-standing assumption is now set to change, according to Aberdeen Adviser.
Under the Government’s proposed reforms, most unused pension funds and death benefits will be brought within the value of a person’s estate for inheritance tax purposes from April 2027. While the changes have prompted widespread discussion across the advice profession, one group of clients may find themselves particularly affected: widows and widowers.
Following the death of a spouse, pension wealth that was previously spread across two estates often becomes concentrated within one. For many surviving spouses, particularly those who have secure retirement income from other sources, that pension may have been earmarked entirely for future generations. The proposed changes could significantly alter that plan.
According to Aberdeen Adviser, this is already becoming a much bigger part of conversations between advisers and their clients.
Andrew Zanelli, Head of Technical Engagement at Aberdeen Adviser, said: “Widowed clients are particularly exposed to the incoming IHT changes on pensions. They’ve usually built up pension wealth as part of a couple, only to find all this now sits in one estate rather than two.
“Many had assumed their pension would stay outside their estate for IHT purposes, but this will cease being the case from April 2027.”
A familiar client scenario
Take the example of Ava, a widow in her late seventies.
Her retirement income is more than sufficient to meet her needs, thanks to a widow’s pension from her late husband’s defined benefit scheme and rental income from buy-to-let properties. As a result, she has never needed to draw on her own defined contribution pension.
Like many clients in a similar position, Ava’s plan had been simple. Leave the pension invested for as long as possible before passing it to her children and grandchildren.
Under the proposed rules, however, that strategy could produce a very different outcome. Not only could the pension now form part of her estate for inheritance tax purposes, but beneficiaries may also face income tax when withdrawing inherited pension funds, creating the possibility of a significant combined tax liability.
Conversations are changing
Zanelli says advisers are increasingly revisiting estate plans with widowed clients who hadn’t expected to reconsider arrangements that had been in place for years.
“We’re hearing from advice firms that this is becoming a bigger part of client conversations, particularly with widowed clients who hadn’t expected to be revisiting their estate plans,” he said.
While there is no one-size-fits-all solution, the proposed reforms are encouraging advisers to look again at how clients intend to pass on wealth and whether existing plans remain appropriate.
Questions advisers may now be discussing include:
- Does the client actually need to preserve their pension untouched?
- Could wealth be passed to the next generation sooner rather than later?
- Does the client’s current estate plan still achieve the intended outcome under the proposed rules?
- Are there opportunities to reduce the overall tax burden while maintaining flexibility?
Planning ahead
One option Aberdeen says is receiving greater attention is regular gifting from surplus income.
Where the relevant conditions are met, gifts made from surplus income are immediately outside the donor’s estate for inheritance tax purposes, avoiding the usual seven-year rule that applies to many lifetime gifts.
In Ava’s case, drawing income from her pension and gifting surplus income into trust for her children and grandchildren could help reduce the potential exposure to both inheritance tax and future income tax, while allowing trustees to control how and when beneficiaries receive the money.
“More advisers are suggesting clients look at surplus income gifting because it solves two problems at once. It gets money to the next generation now when it can make more of a difference, and it takes that money out of the estate straight away without triggering income tax charges on withdrawals,” said Zanelli.
Although the proposed changes are not due to take effect until April 2027, they are already prompting advisers to revisit conversations that many clients believed had been settled. For widowed clients in particular, assumptions that have underpinned estate planning for years may no longer hold true, making now an appropriate time to review existing plans and consider whether any adjustments are needed before the new rules come into force.
