For years, pensions have been one of the most tax-efficient ways to pass wealth down the generations. Thanks to Rachel Reeves, that will change from next April. Now many savers fear their loved ones could face a hefty inheritance tax (IHT) bill when they die. Some families may then face income tax on withdrawals too, creating the prospect of paying tax twice on the same money.
As a result, a growing number of savers are looking for ways to reduce their exposure. One obvious option is to withdraw pension and give it away while you’re still alive. Yet experts warn it could create an entirely different problem further down the line, especially if you need residential care later.
Care Costs Concerns
Lisa Morgan, head of the nursing care fee recovery team at law firm Hugh James, said many families are so focused on IHT that they are also overlooking the potential impact on future care costs. Residential care fees now regularly exceed £8,000 a month, and can be considerably higher depending on where you live. Those costs can quickly erode savings.
Morgan said councils are also becoming far more willing to investigate whether people have deliberately reduced their assets to avoid contributing towards care fees. This is known as "deprivation of assets", and it can have serious consequences.
Deprivation of Assets Explained
When people apply for local authority support with care costs, councils carry out a financial assessment, Morgan said. "If they believe somebody intentionally gave away money or assets to avoid paying for care, they may decide deprivation of assets has occurred."
Common examples include gifting cash to children or grandchildren, transferring property ownership, placing money into trusts, selling assets below market value or spending unusually large sums.
Many people assume there is a fixed time limit on how far councils can look back. Morgan said that's a dangerous misunderstanding. "A common misconception is that inheritance tax planning rules and social care funding rules operate in the same way. They do not."
Gifts may be outside an estate for IHT tax purposes after seven years, but they can still be examined by a local authority when assessing whether someone deliberately reduced their assets to avoid care fees.
Notional Capital and Recovery
If a council concludes deprivation of assets has taken place, it may treat the individual as though they still own the money that was given away. This is known as "notional capital". In some cases, councils can even seek to recover funds from relatives who received gifts.
Morgan said the planned pension tax changes are encouraging families to make decisions that may not have been properly thought through. "Many families are understandably reviewing their estate planning following the proposed pension inheritance tax changes," she said.
But Morgan also issued a warning: "Decisions made to save tax can create significant problems later if future care needs are not properly considered."
Keeping Records
She said people should keep detailed records if they make substantial gifts. These should include financial advice received, evidence of retirement planning, cashflow forecasts, medical information and notes explaining why the gift was made. Such evidence may help demonstrate that the primary purpose was estate planning or family support rather than avoiding care fees.
Morgan urges families to take a balanced approach. The danger is that in trying to dodge one future bill, you could be exposed to an even bigger one.
