Protecting a legacy

Perhaps the most seismic changes to pensions since the introduction of pension freedoms, the announcement that pension pots will be brought within the IHT estate from April 2027 caused waves across the planning world.  And like pension freedoms, it will upend long established wealth planning behaviours.

The original proposal would have seen the pension IHT charge paid by pension administrators from pension funds, meaning any protection policy payout would not be a direct replacement of the lost wealth as it would be outside of the pension wrapper.

The updated legislation requires the personal representatives of the deceased to pay the pension IHT charge, so the life policy benefit can be used to pay, instead of the pension fund itself. This is a far better outcome as the pension funds remain invested and within a tax efficient wrapper, and the personal representatives will have near instant liquidity to pay the IHT charge from the life policy written in trust.
 

The maxim of ‘first in last out’ for pensions will no longer be true. So while the implementation remains a while off, advisers are rightfully already discussing how this affects clients long term strategy, re-organise plans, gifting, spending, removing money from pensions and where to legally and efficiently shelter it. 

When it comes to many of the issues and worries facing wealthier families looking to build and maintain a robust financial plan under this new framework, the role of protection will be significant.  

Crucially, the far reaching impact of the changes will mean that every client with pension wealth is going to need advice. It is a huge advice opportunity for the pensions & protection space, so advisers need to ready themselves for the increased complexity of the solutions available.

The protection solutions

Those that have every expectation of spending the majority of their pension may need to be mindful of the changes, but it is those wealthier individuals who are not planning to use much (if any) of their DC pot whose plans may well need to be rethought.  

Often having worked diligently to build up wealth over their lifetime, the challenge is to get these clients to start thinking about how to get rid of that money. This means either start to spend it, start to gift it, or protect it. And while the first two are pretty straightforward, ‘protecting it’ requires a little more complexity in the planning. There are, however, numerous viable and flexible options to insure against that liability. 

• Whole of Life: What many would view as the ‘ traditional route’ is the use of a Whole of Life policy. While this may suit those leaving large unused pension pots or living a lot longer than average this may not be the default solution. For some clients the costs of whole of life cover may be prohibitive, as well as being offered by a limited choice of insurers.  
• Term Assurance: This is deemed much more accessible in the market. Term Assurance offers lower cost compared to Whole of Life and has the benefit of generally being available to c. 90 yrs old. The product is also very configurable, offering options for single life, joint life first event, as well as joint life second death which is particularly attractive for married couples. Furthermore, if liability decreases, the sum assured can be reduced accordingly, which can in turn reduce premiums. 
• Decreasing Term Assurance: Typically thought of as a liability protection product i.e. protecting a mortgage debt, Decreasing Term Assurance can also be an attractive proposition. If spending & gifting, liability will likely decrease significantly over time. So a decreasing policy may fit the bill nicely. It’s also worth noting that the option exists to have a rate of decrease based on an assumed interest rate from zero to 18, meaning that the rate of interest can be manipulated. Once set off on that decreasing trajectory, however, it will continue until the end of the term.  

For each of these policies, the ability exists to write them into trust. This can help smooth the process of using insurance to protect against this liability and enables easy distribution in a tax efficient way 

This route also avoids the need to wait for grant of probate because insurers can pay straight away as the funds are not going into the estate. This is a positive outcome for the beneficiaries as it means that they will get the funds quicker, even if the estate is complex and takes a long time to wind up.

The funding question

Advisers have the option to be creative in how to generate funding for policy premiums and  there are a range of options available. And given that those most impacted by the IHT changes are predominantly those who have the option of accessing their pension, meaning that this can be a notable option.  

With one of the hurdles to protection being cost. The ability to fund premiums through an asset to which clients already have access lowers that hurdle significantly. This route can also offer incredible value for money compared to the eventual and guaranteed payout.  

It’s also worth noting that accessing a DC pension pot 'flexibly’ may come with certain risk around sustainability and withdrawal rate, particularly in a volatile investment environment. So the reduced risk of the annuity option also increases the attractiveness of this funding option.

The adviser imperative

It is those clients not planning to use all/ any of their pension pots most at risk of the looming ‘unused pension contributions death tax’. And while the implementation date might feel a way off, the planning needs to start now.  

For some clients, a frank conversation needs to be had about whether they will still be alive when the changes kick in. But for those for whom the answer is anything other than a certain no, mitigating steps needs to be put in place. Advisers then will need to work closely with their clients to first size these issues, including detailed cash flow modelling - the extent to which clients will lean into the spending & gifting options available will likely shape the suitable outcome.  

For advisers not regularly or actively involved in the protection space, this will bring them back in and face-to-face with relatively new technology and product changes. In order to ensure they are ready to help best navigate clients through the new tax and product landscape, they will need to refamiliarise themselves with the suite of protection products available and how they best dovetail with the wider wealth planning toolbox. 

Crucially, the one constant is the need for advice both now and as the landscape inevitably evolves. By giving genuine holistic multi faceted advice, advisers have an opportunity to deliver impactful wealth planning, as well as adding real value to the relationship with clients and their families.