Passing on wealth: Pensions and guaranteed income solutions

26 March 2024

Pensions can be a tax efficient mens to pass on wealth but what if the benefactor also needs to draw income? How can capital be preserved while sufficient income is generated? Tony Hicks, head of Sales, Copia Capital Management looks at the issue.

For many people, providing ongoing financial security for their loved ones via an inheritance is a crucial part of their financial planning. Although legacy planning can be an emotive subject, it’s an important part of the conversation when considering retirement income options to ensure clients make the most of their wealth, especially as nearly three-quarters of UK adults expect to leave a legacy when they die, according to research by probate specialist Tower Street Finance[i].

Part of the planning process will be looking at ways to mitigate inheritance tax liability. Latest HMRC figures put IHT receipts at £6.8 billion from April 2023 to February 2024, marking a £400,000 increase on the same period in the previous year. There has been a largely upward trend in IHT receipts over the last decade[ii] and analysis by estate administration service Kings Court Trust suggests that this is set to continue. It estimates that over the next thirty years, a staggering £5.5 trillion of wealth will be transferred between generations.

Despite speculation that there would be cuts to the IHT rate or increases in the allowances in the Budget, they didn’t materialise. The Budget papers state there will be no changes to IHT before 6 April 2025, although they do announce the intention to consult on a move to a residence-based regime for IHT as part of the Government’s non-dom reforms.

Given the current rules around IHT, using their pension as a tool for estate planning could be an attractive option, especially for wealthy clients who aren’t reliant on their entire pension for income in retirement. Pensions offer the advantage of typically falling outside the client’s wealth for IHT assessment purposes, which can make them a tax efficient way of leaving a legacy.

The tax treatment depends on the client’s age when they die. If they pass away before reaching 75, beneficiaries – who are not limited to immediate family members – can receive benefits tax-free. If they are over 75, beneficiaries are subject to taxation at their respective marginal income tax rates. Given the current IHT rate of 40%, inheriting wealth via a pension could potentially save 20% in tax for basic-rate taxpayers compared to inheriting other assets held within the estate.

Preserving capital while delivering income

The challenge for clients wanting to use their pension fund to leave a legacy as well as provide an income in retirement, is preserving the capital value of the portfolio so there is some wealth leftover when they die. This requires advisers to manage the risk of the client outliving their fund, as well as the issue of generating income without depleting the portfolio in periods of market volatility.

One possible approach is to include a guaranteed income producing asset within the client’s SIPP portfolio alongside a purpose-built decumulation investment strategy. Offering attractive rates of income personalised to the client by age, postcode, health and lifestyle, guaranteed income solutions are 100% uncorrelated to other asset classes. This allows some of the portfolio’s overall risk budget can be reallocated towards the investment strategy, favouring equity and alternative assets over traditional bonds, offering greater potential for growth.

In addition, with the guaranteed income solution paying an income for life, less income is required each month from the remaining investment portfolio, so more of the assets stay invested for longer, providing protection against the effects of sequencing risk and increasing the opportunity to outperform.

This can have a significant impact on the size of the client’s legacy pot according to our analysis of Copia’s Select Retirement Income Plus (RI+) portfolio, which blends a guaranteed income asset provided by Just SLI with an investment portfolio managed by Copia’s expert portfolio managers. Putting a theoretical £400,000 portfolio paying income of 4% to a client from age 70 to 97 through Timeline’s stochastic modelling functionality suggests that RI+ would leave a legacy pot worth £252,000 after 27 years, almost twice as much as the same portfolio invested 50% in equities and 50% bonds, which would leave £127,000.

And if all the guaranteed income isn’t required each month, it can be reinvested in the accompanying investment portfolio to offer an even greater opportunity for capital growth. Taking the same theoretical £400,000 portfolios but reinvesting all the income would create a legacy pot worth over £1 million with RI+, compared to £771,000 for the traditional 50/50 bond/equity portfolio.

With rising inheritance tax receipts and greater wealth transferring between generations, pensions are likely to play an increasing role in legacy planning. Innovative decumulation portfolio strategies can not only protect pension wealth from longevity and sequencing risk, but also provide a more tax-efficient way to leave a generous legacy for their loved ones.



Professional Paraplanner