Are pensions still worth it?

Over the past year, many clients have asked, “Are pensions still worth it?” The main reason is the expected change from April 2027, where unused pension funds are due to be included in the estate for inheritance tax purposes. It’s understandable this has caused concern, and some headlines have made it sound as though pensions have lost their value overnight.

“Some of my clients feel pension rules change so often that it’s hard to know where you stand and, increasingly, some people are worried pensions could be taxed twice; once through inheritance tax on death, and again through income tax when the money is eventually withdrawn” says Liza Pontone, chartered financial planner

“Those concerns are completely reasonable.  While the conclusion is understandable, it isn’t the full picture”

“Even with the changes, pensions still offer valuable tax advantages during your lifetime and can remain an important part of long-term planning”

The key reason pensions remain so effective is due to the tax relief. If you are a higher rate tax payer whilst working, pension contributions can receive a significant uplift immediately, before any investment growth is even considered. A recent piece by Fidelity illustrated this by looking at the journey from paying into a pension to taking money out later.

Put simply, imagine you pay £6,000 into a pension. Because of higher-rate tax relief, that could mean £10,000 ends up invested and when you come to take benefits, you can usually take 25% tax free. If the remainder is taxed at basic rate, the total you could receive would be around £8,500. This is compared with the £6,000 you paid in – that’s an uplift of approximately 41.67% and that is before any growth is added. It’s a striking example of how pensions can provide a significant advantage purely because of how they are taxed.

This is also why the April 2027 inheritance tax change needs to be kept in perspective. If inheritance tax applies to unused pension funds, in many cases it may simply reduce, or even cancel out, some of the tax relief that was received in the first place. In other words, it can be viewed as the government clawing back some of what it gave rather than pensions suddenly becoming “pointless”.

That said, the change does mean some strategies need to evolve. The long-standing idea of “fund the pension first and spend it last” may not be right for everyone, particularly where estate planning is a key objective. The right approach will depend on individual circumstances, income needs, and who you would like to benefit from your wealth.

“Pensions continue to be one of the most tax-efficient ways to save for retirement” continues Liza “The key is to use them as part of a wider plan, alongside other tax-efficient vehicles, in a way that supports your income needs throughout retirement and your longer-term family goals. With the support of a Financial Planner, you can build a clear and robust strategy, even as the rules change over time”

Source: Fidelity