Property wealth could provide homeowners with a cheaper way to fund retirement after the Chancellor’s changes to the Lifetime Allowance for pensions.
Older homeowners could save money by using their property wealth to fund their retirement rather than drawing down from their pension pots, following changes made by the Chancellor to the Lifetime Allowance (LTA) for pensions in his March budget.
The LTA is the maximum amount an individual can save into their pension pot over their lifetime without incurring a tax charge. Previously, you could save up to £1,073,100 without being taxed. The Chancellor’s decision to abolish this cap completely will encourage the wealthy to save more into their pensions and could also result in a significant change in the way high-net-worth individuals choose to fund their retirement, says Knight Frank Finance head of later life finance, David Forsdyke.
“High-net-worth clients are always looking for tax efficient ways to pass their wealth on to their beneficiaries, especially when they reach their 70s. Pensions are usually exempt from Inheritance Tax (IHT) and are therefore a very tax efficient way to do this,” says David. “The change to the LTA cap will enable high-net-worth individuals to save more, and retain more, in their pension pots. Property on the other hand is subject to IHT, so for high-net-worth homeowners with a property worth £2m or more, it could be that using their property wealth to fund their retirement is more efficient than using their pension funds.”
At the same time, other measures remain in place. The amount of tax-free money you can take from your pension will stay at 25% of the current LTA. This means you can only withdraw a maximum of £268,275 tax-free, with anything drawn from your pension above this amount taxed at your marginal rate of income tax.
“Wealthy individuals will be encouraged, then, to explore alternative options for funding their retirement. There is a growing trend of homeowners choosing to access the value of their homes via products such as a Lifetime Mortgage, which is the modern form of equity release, rather than relying on their pension funds. I can see this increasing in light of the budget announcement,” says David.
A Lifetime Mortgage is a loan secured against your home. In addition to creating liquid funds based on the equity in your property, it establishes a mortgage debt on your home, reducing the value of your estate upon which your IHT liability is calculated and in turn reducing the tax burden your beneficiaries could face.
The move has been welcomed by many in the financial industry, who believe that it will encourage greater flexibility in retirement planning and encourage a more diverse range of options for funding later life.
- A scenario: Property or pension?
A retired widow in her mid-70s has a property worth £3m. She took her tax-free allowance from her pension fund when she retired, so any future withdrawals are taxable at her marginal rate of income tax. She has a state pension and an employee pension scheme which give her £17,000 per year (before tax). She needs to top this up by £41,000 each year to maintain her lifestyle, and keep the property and grounds in good repair. To achieve this, she will need to draw down £54,470 from her pension each year (based on the 2023/24 income tax regime). After 10 years, this will have cost £544,700 from her pension and the potential IHT bill on the house will stand at £1,070,000 (based on the current IHT regime. Assumes no growth in the value of the property). Together these reduce the theoretical value of her estate by £1,614,700.
By comparison, if we look at the same £41,000 taken each year using the drawdown facility available with a lifetime mortgage, the mortgage balance would grow to £602,492 after 10 years (assuming an interest rate of 5.70%). However, the potential IHT bill on the house will have dropped to £829,003 because the homeowner now has a mortgage debt against it, reducing its taxable value. In this scenario, her estate is reduced by £1,431,495, which is £180,000+ less than in the previous scenario. In other words, her beneficiaries could potentially inherit £180,000 more if she passes away in 10 years’ time. In addition, this second scenario allows her to hold more funds in her pension. There is of course investment risk to consider, depending on which funds her pension is in, but growth assumptions being made by advisors over the long term are still positive.
If you are interested in exploring how a lifetime mortgage could be used in your retirement and would like to discuss your options, contact our experts who would be happy to help. We have access to all providers and can help you find the most suitable solution available in today’s market.