The landscape of retirement planning has shifted dramatically over the years. Since Pension Freedom was introduced in 2015, many financial advisers have encouraged clients to use pensions both as an income source and an inheritance planning tool. However, with the recent changes announced in the 2024 Autumn Budget, retirement planning strategies require a serious rethink.
What’s Changing?
Traditionally, pensions were exempt from Inheritance Tax (IHT), allowing individuals to pass their pension pots to beneficiaries tax-free, with income tax only payable on withdrawals on death after age 75. This was a game-changer for those looking to build a financial legacy for their loved ones.
However, from April 2027, to better align with broader fiscal policy pensions will become subject to IHT at 40%, significantly reducing the amount beneficiaries receive. On top of that, when beneficiaries withdraw pension funds, they will also pay income tax at their marginal rate. This could mean a total tax rate of 62% or more, and for those inheriting larger estates, up to 90%.
Is a Pension Still the Best Retirement Investment?
Given these changes, the question arises: Should I still invest in a pension, or are other options better?
Comparing Retirement Investment Options
We’ve run the numbers, and assuming that the investment duration and tax treatment at both contribution and withdrawal remain consistent, pensions still come out on top for basic rate taxpayers. For higher rate taxpayers, we have the same outcome on a Pension and an ISA (unless the client taxes tax free cash prior to death, in which case the Pension is better). Here’s why:
| Investment Type | Growth Rate (FCA Projection) | Initial Investment | Final Value Before IHT | After IHT (40%) | After Income Tax (if applicable) | Effective Tax Rate |
|---|---|---|---|---|---|---|
| Pension (Basic Rate Taxpayer) | 5% p.a. | £13,333 | £35,377 | £21,226 | £16,981 (after 20% tax) | 52% |
| Pension (Higher Rate Taxpayer) | 5% p.a. | £16,667 | £44,221 | £26,533 | £15,920 (after 40% tax) | 64% |
| Pension & Cash (BRT) | 5% p.a. | £13,333 | £35,377 | £21,226 | £18,042 (after 15% tax) | 49% |
| Pension & Cash (HRT) | 5% p.a. | £16,667 | £44,221 | £26,533 | £18,573 (after 30% tax) | 58% |
| ISA | 5% p.a. | £10,000 | £26,533 | £15,920 | £15,920 (Tax-free) | 40% |
| GIA | 4.5% p.a. | £10,000 | £24,117 | £14,470 | £14,470 (after CGT planning) | 40% |
Assumptions Used in the Calculation
To provide an accurate comparison, we based our calculations on several key assumptions. We used the FCA’s prescribed intermediate growth rates of 5% per annum for pensions and ISAs and 4.5% per annum for GIAs, reflecting realistic long-term investment returns. Different growth rates are used for GIAs (4.5% p.a.) compared to pensions and ISAs (5% p.a.), as GIAs are subject to tax on income and capital gains. The FCA considers this a realistic long-term outlook. We assumed a 20-year investment horizon to align with a typical retirement planning timeframe. The initial investment for pensions was adjusted to reflect tax relief, meaning a basic rate taxpayer would invest £13,333 for a contribution of £10,000, and a higher rate taxpayer would invest £16,667. However, for a fair comparison, ISA and GIA contributions remained at £10,000, as they do not benefit from tax relief on contributions. Inheritance Tax (IHT) was applied at 40%, in line with the proposed 2027 rules, and income tax was calculated based on basic (20%) and higher (40%) taxpayer rates at withdrawal. For GIAs, by after CGT planning we mean that capital gains tax (CGT) was assumed to be managed efficiently through allowances. These assumptions ensure the figures reflect real-world conditions, helping investors make informed decisions about their retirement savings. If maximum tax free cash had been taken immediately prior to death of 25% of the fund, the effective income tax rates are reduced accordingly. These differences reflect varying withdrawal strategies (e.g. different levels of tax-free cash or accelerated drawdown).
Disclaimer:
Investment values can go down as well as up, and past performance is not a reliable indicator of future results. There is no guarantee that any investment strategy or product will achieve its intended outcome. Before making any investment decisions, you should assess your own financial situation and risk tolerance, and consider seeking independent professional advice.
A Cautionary Tale
If your beneficiaries are taxed at a higher rate than you were when you made the contribution, the ISA would have been the better investment, as the deferred tax rate on the pension is higher than the relief given when the contribution was made.
Scenario: The contributer is a basic rate taxpayer & the beneficiary is a higher rate taxpayer.
| Investment Type | Growth Rate (FCA Projection) | Initial Investment | Final Value Before IHT | After IHT (40%) | After Income Tax (if applicable) | Effective Tax Rate |
|---|---|---|---|---|---|---|
| Pension (Basic Rate Taxpayer) | 5% p.a. | £13,333 | £35,377 | £21,226 | £12,736 (after 40% tax) | 64% |
| Pension & Cash (BRT) | 5% p.a. | £13,333 | £35,377 | £21,226 | £14,858 (after 30% tax) | 58% |
| ISA | 5% p.a. | £10,000 | £26,533 | £15,920 | £15,920 (Tax-free) | 40% |
| GIA | 4.5% p.a. | £10,000 | £24,117 | £14,470 | £14,470 (after CGT planning) | 40% |
If you you drawdown at an accelerated rate to avoid leaving an inherited pension, this too could cause the deferred tax rate on the pension to be higher than the relief given when the contribution was made.
Scenario: The contributor accelerates decumulation to outlive their capital.
| Investment Type | Growth Rate (FCA Projection) | Initial Investment | Final Value Before IHT | No IHT | After Income Tax (if applicable) | Effective Tax Rate |
|---|---|---|---|---|---|---|
| Pension & Cash (BRT) | 5% p.a. | £13,333 | £35,377 | – | £24,764 (after 30% tax) | 30% |
| ISA | 5% p.a. | £10,000 | £26,533 | – | £26,533 (Tax-free) | 0% |
| GIA | 4.5% p.a. | £10,000 | £24,117 | – | £24,117 (after CGT planning) | 0% |
There are many variables at play here. You don’t know when you are going to die. If you draw too much you risk outliving your capital. If you don’t draw enough you risk double taxation on your savings.
What’s the Best Strategy Moving Forward?
With pensions now falling under IHT, it’s time to rethink retirement strategies. Here are some key considerations:
- Maximise ISA Contributions – ISAs remain completely tax-free, during your lifetime. If leaving a legacy is important, ISAs should now play a central role in retirement planning.
- Consider GIAs for Flexibility – While GIAs are subject to capital gains tax (CGT), strategic withdrawals can minimise tax liabilities.
- Think Carefully About Pension Contributions – Given the new IHT implications, making additional pension contributions may not be as beneficial. It might be better to use pensions for retirement income rather than as an inheritance tool.
- Annuities Are Back in the Spotlight – With bond yields rising, annuities are once again a solid option for those seeking guaranteed income. They remove the risk of IHT issues, as generally the pot dies with you, and ensure lifelong security.
- Inheritance Planning is Key – Those with large pension pots should seek professional financial planning to mitigate the impact of IHT and income tax on their beneficiaries.
Conclusion: The Importance of Proactive Planning
Financial planning should always be based on the rules as they stand, not political speculation. While some experts believe the IHT pension changes might never be implemented due to complexity, it’s crucial to prepare for the worst while hoping for the best.
For now, smart retirement planning means diversifying beyond pensions, maximising the use of ISAs, considering GIAs for growth, carefully consider the sequence in which you withdraw from your GIA, ISA, and pension portfolios, and reassessing the role of annuities. With the right strategy, you can still achieve financial security and ensure your wealth benefits your loved ones—not the taxman.
If you’re unsure about how these changes affect your retirement plans, seek professional guidance. The sooner you plan, the more options you’ll have to safeguard your future.
Next Steps:
- Review your current pension contributions – Are they still the best option for you?
- Look at alternative investments – Could ISAs or GIAs provide a better outcome?
- Speak to a financial planner – A professional can help create a tax-efficient retirement strategy tailored to your needs.
Retirement planning isn’t just about today—it’s about securing your future and leaving a legacy on your terms. Financial planning should be based on current regulations rather than political speculation. By diversifying your retirement investments—maximising ISAs, utilising GIAs for growth, and reassessing the role of pensions—you can safeguard your future and ensure your wealth benefits your loved ones, not the taxman. If you’re unsure how these changes affect your retirement plans, seek professional advice as soon as possible.
Disclaimer:
The information provided is for general informational purposes only and does not constitute financial, tax, or legal advice. Please be aware that political risks are inherent, as successive governments may alter policies, including the taxation of pensions. Such changes can significantly affect the value of your retirement savings and investment outcomes. Past performance and current tax regimes are not indicative of future results. It is essential to consult with an independent financial adviser to ensure that your strategy remains appropriate in light of potential regulatory and policy changes.
Academy of Life Planning 
“Some financial advisers and providers have lauded the change, saying that pensions are for retirement income. This is an odd statement on two counts:
I, for one, will make no further SIPP contributions. There is simply no point. Of course, it might never happen – Sir Steve Webb thinks not due to the complexity of administration of estates. I hope he is right.” – Clive Waller, Money Marketing. 31 January 2025.