New inheritance tax rules have created “serious challenges” for thousands of retirement savers holding illiquid assets in their pensions, such as commercial property, advisers warn.
Because of the size of their funds, wealthier pension savers have typically been able to access a wider choice of investment options than the traditional “vanilla” stocks and shares portfolio.
One investment option popular with the wealthier self-employed has been to use a self-invested personal pension (Sipp) to buy their business premises, a strategy that has financial benefits for the company and the pension fund.
But advisers say the Labour government’s decision to bring pensions into the scope of inheritance tax in 2027 has created new headaches for those who hold commercial property in their Sipps.
“The proposed changes stipulate that the pension scheme must settle its portion of any IHT, which means the scheme may potentially have to sell an illiquid property asset — which a firm operates from — in a very tight 60-day timescale to meet a tax bill (or end up incurring penalties),” says Jason Hollands, managing director of Evelyn Partners.
“It is nigh on impossible to sell a commercial property such as a factory or warehouse within 60 days.”
Under the new IHT regime, in force from April 2027, funds that have not been accessed in a defined contribution (DC) pension, at the time of the pension holder’s death, will be subject to both income tax and IHT at the rate of 40 per cent, levied on funds above the nil-rate band.
Currently, funds untouched in a DC pension can pass to a beneficiary tax free if the death is before age 75, or with income tax to be paid at the recipient’s marginal rate if the death is at age 75 or over.
To avert future IHT issues, Hollands suggests that someone owning property in their pension might now have to build up a cash reserve to meet a future IHT liability — perhaps by not drawing the rental income they were meant to live off.
But in doing so, they would inflate the value of the pension and the IHT liability, he adds. Selling the property to the business while they are alive is another solution but could be a financial burden for a small business.
“This change is a serious challenge for those who have these properties in their pensions, but the bigger angle is the disruptive situation lots of SMEs are going to plunge into,” said Hollands, who estimates there are around 15,000 business premises owned by pensions.
“This is a poorly designed policy that hasn’t considered the consequences.”
Meanwhile, in terms of retirement strategy, advisers say the 2027 inheritance tax changes are changing how savers approach their pension planning.
Katherine Waller, co-founder of wealth manager Six Degrees, said when outside the scope of IHT, it was common for pensions to be regarded as a “very long-term pot, earmarked for the children”, and the risk profile to be commensurate with that time horizon.
“Nowadays it’s more common for clients to take their pension commencement lump sum, and draw from their pensions in their lifetimes, meaning a slightly more measured approach — and reduced capacity — for risk,” she adds.
The IHT concerns are also triggering portfolio rethinks for pension savers who are invested in traditional portfolios, comprising mostly equities, fixed income and cash, which make up the bulk of £1mn-plus funds.
Most wealth managers report larger funds are invested at higher risk levels than average, with the majority of the portfolio in equities.
Nicholas Nesbitt, financial planning partner at Forvis Mazars, said some clients were now starting to reassess this high equity exposure because of the planned IHT changes from April 2027.
“We are now seeing many large pension funds being ‘stripped out’ due to fears of suffering double or triple-taxation on death,” says Nesbitt.
He adds: “It’s hard to know if it is the propensity for risk that has led to them having a large pension fund, or whether having a larger fund makes them more confident in taking risk.”
Alongside the de-risking of pension funds, RBC Wealth Management has seen clients adding fixed income and money market funds to reduce volatility, and the timing may be good for this switch.
“Fixed income returns have increased and are generating real returns above inflation and after costs again,” says James Baxter, founder of wealth manager Tideway Wealth.
Fresh challenges for entrepreneurs holding commercial property in their retirement funds come against a broader retreat from alternative assets by some self-invested personal pension providers.
Non-standard assets, such as unquoted assets and loans to unconnected, unquoted UK limited companies can offer diversification and the potential for higher returns, but are regarded as riskier for both the pension holder and provider and are subject to higher levels of regulatory scrutiny.
“The ability for investors to add less liquid or more esoteric investments within their pension wrappers is reducing,” says Charlotte Ransom, chief executive officer at Netwealth.
With the IHT reforms prompting changes to investment allocation for wealthier savers, some advisers are keen to reverse the shift away from alternative assets in private pension funds.
“Younger people want to put crypto in their pensions, so the regulator will be forced to think about it,” warns Nick Perrett, chief executive of Prosper, a wealth manager.
