Hello and welcome to On The Money, a weekly show that aims to help you make the most out of your savings and investments. For the second successive week, I'm joined by Craig Rickman who is personal finance editor at Interactive Investor. So given that we're in the start of a new tax year, the focus of this episode is explaining why the term use it or lose it has never been so important for a particular tax year. So the reason why is because in the next tax year from 04/06/2027, there are a number of rule changes. The most prominent is that pensions will be caught by inheritance tax from that point onwards.

There's also changes to the cash ISO allowance for those that are under the age of 65, and that can be changes to the amount that people pay in savings tax. Have I missed anything else, Craig?

No. No. That's you've you've covered it off there perfectly.

So let's talk about the cash ISO first. So from 04/06/2027, the cash ISA allowance will be reduced from £20,000 a year to £12,000 a year for those under the age of 65. So, Craig, a year ahead of this change being brought in, should those under the age of 65 now be filling up the £20,000 allowance before it's cut to £12,000?

Well, is a question that some people may be be asking themselves or or perhaps one of a couple of questions. One is that whether they should fill up the the 20,000 cash ISO allowance while it's still that size. The other concerns transfers because from the 04/06/2027, you'll no longer be able to transfer from stocks and shares to a cash ISA. They're still permitted at the moment or will be permitted for the for the current tax year. So they're they're the the two big questions.

I guess my view is is that, you know, whatever happens to the, you know, the cash ISA framework, cash ISA allowances, the principles of saving and investing remain the same, which is if you've for any short term needs, you know, short term spend or emergencies, cash, the security offered by cash tends to be sort of the most suitable thing. But when you're looking longer term, five years plus investing in the stock market, so in this case, stocks and shares ISA would be the more appropriate thing to do. So I think it's important for people to be aware of that. I guess the other side to it is if you are looking to to derisk within your portfolio, there are other ways to do it. You know, if you've got money in a stocks and shares ISO now and you're looking to to reduce the amount of risk with some of your holdings, for example, you don't have to transfer it to a cash buyer.

So there are other things that you can do within the wrapper to to achieve that. And for those that have money in savings that could mean that they breach the annual savings allowance, Those in that position, they might be thinking, this

is my last chance to move some of that money into a cash ISA so that I'm not hitting the pocket in terms of paying the savings tax.

Absolutely. Yeah. Yeah. And yeah, the we should note the the the savings allowance is is quite useful thing for people. We should note that that that depending on which tax band you fall into can dictate how much of your interest you can earn tax free.

So if you're for most basic rate taxpayers, you can earn a thousand pounds in in interest. Some if you're in a particularly low income, so if you earn less than the personal allowance or the tax free personal allowance, which is 12,570, you can get a savings allowance up to £5,000, potentially £6,000, but you have to have a low income to to to enjoy one of those. If you're a high rate taxpayer, your savings allowance falls to £500 and additional rate taxpayers don't get a savings allowance. So this is another thing that that people may need to think about, especially as you noted from the start that the tax rates on savings interest is due to increase from next April as well. So, you know, across the board, across the basic rate, the higher rate, and the additional rate, they're going up two percentage points.

So that's, yeah, that's a big consideration for people for this tax year because, yeah, from next April, if you're under 65, you have a smaller cash ISA allowance. And for any money outside which exceeds your savings allowance, provided you get one, will be taxed at a higher rate than it is currently. And in

terms of cash, of course, you can hold cash in a stocks and shares ISA, including through a money market fund. However, there are question marks at the moment as to whether from 04/06/2027, whether you'll still be able to have money market funds in a stocks and shares ISA. There's a consultation underway at the moment, and we'll hopefully know the outcome of that, you know, in the in the not too distant future so that people can save and plan accordingly. We've spoken about this on the podcast before. My personal view is that I think this would be quite hard to administer.

It could potentially be pretty messy. And who's the onus on? You know, is it on platform providers or is it on the individual not to buy those funds in the stocks and shares ISA?

Yeah. And, you know, in addition to that, there are there are really good reasons to to use money market funds in a in a stocks and shares ISA. Like like we were talking about earlier, you know, people may want to to to take risk off the table even for a short period. If that were to be the case and and they wanted to put their money in money market funds to provide some short term security, If they were then paying tax or taxed on those returns, it would be would seem unfair. It would fly in the face of the purpose of of an ISA and the types of investment strategies that that people employ.

So it's gonna be really interesting to see the outcomes of of this and what the the sort of exact position will be come the April 6 year, and investors will be keeping a close eye on that.

I'm only guessing here, but I think the the concerns that have prompted this consultation about money market funds and stocks and shares ISAs, to me, they potentially stem from concerns that some people will just fill their allowance just with a money market funds. So, you know, if if it's a lower cash ISA allowance going forwards, then that's what they'll do to bridge that. However, I think it's just important to go back to the drawing board and educate people on what money market funds are, why they should be why they are useful, but they should only form part of, you know, a smaller part of a portfolio rather than having your whole portfolio in them. Because, yes, at the moment, you can get a a yield on a money market fund around 3.75%, which as they typically yield the same level where UK interest rates are. But if if that's, you know, if you if you just fill your ISO with money market fund or funds, then you're you know, you're gonna be sacrificing long term growth at the end of the day.

You know, it should be viewed as a defensive part of a well diversified portfolio having some exposure to money market funds. Absolutely.

Yeah. Yeah. And I guess also with with money market funds, it could also provide a bit of a gateway to those who aren't used to investing or aren't familiar with it. If they know that they can invest in something sort of cash like when they open a stocks and shares ISA and then can sort of gradually expose themselves to the higher risks but potentially higher returns of investing in the stock market, then that's that's a possibility as well. And we and we know that the government is key.

That's a that's a problem the government is keen to solve is to get more people investing rather than rather than saving. So perhaps it would close off one of the avenues for that as well.

And I also think, say, if money market funds were excluded from stocks and shares ISAs, so these funds, they typically invest in bonds that mature in over a couple of month periods. They're very low risk, and they're invested in very high quality bonds that are issued by banks, for example. I think then people would then look at the next level of risk up, and they'd look at bond funds that then invest in bonds that mature within one to five years, cause that's the next level of risk. And those types of funds, they offer a higher yield than a money market fund, typically around one percentage point higher. That's then the next level up in terms of going from, say, a money market funds to the next level on the on the risk spectrum.

I think I think people would then turn to those types of products. So I I think there's a danger that if you yeah. If you well, not a danger, but if if you if you take away one type of funds, people then go searching for the next thing.

Yep. Yep. Absolutely. That it's it's yeah. It would be a it would be a contentious move.

It seems like there's there's a there's a there's a bit of a disagreement going on between investment platforms and bearing societies about, you know, how that should work. But, yeah, I mean, we'll we'll we'll definitely get the outcomes of that. We'll have to get the outcomes of that before the cash I ISA change comes in next year.

So while we will keep listeners posted on that, I'm sure once we have some clarity over whether money market funds can continue to be in a stock and shares ISA, we'll cover on the podcast once we have the the outcome of that. However, something contentious that we do know is gonna happen is the fact that from the 04/06/2027, unspent pension funds will be caught by inheritance tax. Firstly, Craig, could you set the scene and explain what is changing?

I sure can. So I think the first thing to say, this is a this is a big change. It was announced at the the autumn budget 2024. So as you say, from the 04/06/2027, unspent, unused pension funds on death will be added to an individual's estate and could be and whoever receives it could pay inherit ance tax. There are some important things to understand about the the the mechanics of it.

So, yeah, so it will be added to your estate along with your other assets. So it means you can still use your the the the lifetime tax free limit. So your nil rate band, which is 325,000. If you own a home that you pass to children or grandchildren, what's classed as direct descendants, you can get an extra £175,000. So those tax free allowances remain.

So it's only if your your pension assets or any any pension assets which exceed those amounts, and also anything you leave to a spouse or civil partner is tax free as well. So So they're important things to remember. But, yeah, I think and this is, you know, for for those affected by this change, one of the big things they need to be thinking about is to plan ahead, plan ahead of the impact of it, and we can go into some more of the reasoning about that in a second. But the the planning aspect here is is quite tricky or very tricky because the the rules sort of come in as on a on a cliff edge on the 04/06/2027. So if you were to pass away before that, your pension would be exempt from inheritance tax.

If you pass away after that, then it you could whoever receives it could pay inheritance tax. So if you took someone with a particularly large pension, let's say they had or big pension, let's say they had half £1,000,000 in there, that could be the difference. That's a that's a £200,000 difference between dying, you know, on the April 5 next year and the April 6. Makes planning tricky, but nevertheless, that's something that that is a really important task for people affected to to sort of think about over the next twelve months.

And why has this rule come about? Is it simply so the government can raise more tax revenue?

I mean, that might be one reason, but when you look at the the projected revenues from this change, that doesn't really stack up. So it's expected to impact around 50,000 people a year. Ten ten and a half thousand people will be brought into the inheritance tax net as a result of this change and an expected 38 and a half thousand people will pay more inheritance tax as a result with the average bill, you know, the average extra bill being around 34,000 according to government statistics. But in terms of revenues by can't remember the exact year. Think it's 2030.

It's expected to raise 1 and a half billion a year, which isn't a huge amount when you consider The UK's tax revenue total UK tax tax revenues are around a trillion pounds. So it's it's sort of a it's a tiny amount, you know, it's not the same as jacking up the headline rates of income tax or national insurance, for example, which can raise a lot more revenues. It's not the same as prolonging fiscal drag like we saw at the previous budget. They're far more lucrative. But I think also sort of the other big thing for the government is that they're keen to to make sure that pensions are used for their primary purpose, which is to provide retirement income.

So at the moment, they have, you know, they offer some very, very attractive inheritance tax perks provided everything goes through, that will change on on April. But in terms of the revenues, compared to other tax changes that we've seen recently, they're they're relatively small.

So Craig, you mentioned earlier the importance of planning ahead. So those that are impacted by the change to pensions in regards to inheritance tax, they have a year to get their affairs in order. So what what is the first thing they should consider? Yes. Yeah.

I think, you know, if you're looking to plan ahead of this change, it's important to look at your sort of wider financial picture, you know,

take that take that into consideration. Some strategies that have been that work at the moment may change. So one is that while pensions are inheritance tax free or where they have been inheritance tax free, something that sort of many people have done in retirement if they've retired with pensions and ISAs is draw from their ISA portfolio first, preserving the pension pot as, you know, because it's inheritance tax free and ISAs won't be. But some people might be thinking about switching the order around. I think some people might be might be doing that already in light of the change with with pensions, particularly due to this sort of potential tax double whammy that that can apply if you die after age 75.

So at the moment, if you die before age 75, there's no inheritance tax. And if you die after age 75, there's no inheritance tax. But after age 75, whoever receives the pension pays will pay income tax on any withdrawals at their marginal rate of tax. So after the 04/06/2027, whoever receives it could pay both inheritance tax and income tax on what they receive so that, you know, the the tax rates involved could be mid sixties, perhaps even higher. So that's the thinking there.

So I think but but I think as a as a sort of as a as a starting point, people need to check their inheritance tax position with regards to the pension. Because like because like we said, if it if it goes to a spouse or a civil partner, no inheritance tax to pay. If it's an unmarried partner, there could be, but there are various tax free allowances that you can use, nil rate band, residents nil rate band, that you can set against the potential bill. So I think it's really important for people to work out where they stand and then they can plan what to do after that.

And in terms of putting money into an ISA, there's nothing to stop people using some of the pension tax free lump sum and funding into the ISA? I mean, obviously, there's there's the ISA allowance limit to £20,000, but that could be something that people increasingly think of doing going forward.

Yeah. I think we are and we're already seeing it already. We've seen people approach their pension withdrawals in in a sort of a slightly different way through a different lens. So, you know, one tactic is to, you know, withdraw money out of the tax free lump sum and put it in their own ISA, But for those who are particularly concerned about inheritance tax, the tactic may be to access their pension savings and pass them down generations. So as you mentioned, the tax free element will be for those who are in that position, have a who have an inheritance tax problem, might be an obvious first port of call because they can hook the money out of their pension without being landed with a tax bill themselves and then pass it down.

There could be some inheritance tax implications which we'll come on to in a sec, I'm sure. But even for those who are who are making withdrawals from their pensions that are taxable, there still might be some things that they can do to offset the tax. So one example might be to pay into a to an adult child's pension. So if you take a taxable withdrawal from your pension, let's say you pay 20% tax, you pay into an adult child's pension, then they can get you get an upfront boost, upfront tax relief to the tune of 20% straight away. So you've offset the tax that you've paid.

If they're a higher rate or an additional rate tax payer or land in one of the tax traps, for example, then they can can offset some extra tax back. They can claim some extra tax back via self assessment. So that can be a particularly tax efficient way of doing it, especially as, you know, a lot of the research says that younger generations are are falling short of their of their sort of of the the amount of money that they need to save for for retirement. So that might be a really effective sort of intergenerational ploy. One thing to watch out for there is that that you're not sort of kicking the inheritance tax problem down to the next generation because if they've already got an inheritance tax problem, then then you could be adding to it.

So in that case, you know, it can make sense to skip a generation and paying to to pensions for grandchildren or into ISIS or or whatever. But I think, you know, in answer to your question, yeah, I mean, this will prompt and has already prompted people to, yeah, to look at their pensions in a different way and and sort of employ some different income strategies.

And there are certain gifting rules related to inheritance tax. We could devote a whole podcast episodes to these rules, and I do think they are some of them are quite complicated to get your heads around. However, Craig, which ones would you highlight for people that are trying to reduce their inheritance tax liability in light of the changes that are going to come into place next April for pensions?

Sure. Yeah. So the main ones, there's something called the the annual gifting allowance, which is £3,000. So the first £3,000 that you give away every year is tax free. If you didn't use the previous year's allowance, you can bring that forward.

That's per individual so a couple could effectively give away what's that? £12,000 this tax year, and that wouldn't that wouldn't be liable for inheritance tax. Beyond that, there's something called the gifts out of surplus income rule, which essentially is just that. So if if you have any surplus income left over at the end of the year, then you can give that to whoever you want and you get an immediate immediate relief from inheritance tax. There are some specific rules that people need to to watch there.

So the gifts need to be made from income and not capital. They need to be regular in nature and not affect your standard of living. You also will want to keep some some pretty stringent records so that you can prove to the tax authorities that that you you you qualified for that rule. But that could be a really useful rule for people to use, particularly those who are looking to sort of pass assets down generations in light of this big change.

And am I right in thinking the pension withdrawals are permitted within the gift and rules for inheritance tax?

That's the understanding. Yes. Provided it meets the criteria that we've just spoken about. So then provided the the gifts then are regular in nature and don't affect the standard of living, then the understanding is that, yes, they they can qualify under the gifts out of surplus income rules.

And I suppose the last point to make is, you know, if you are gifted and, you know, I think it's great people thinking about passing on wealth to children, grandchildren, etcetera, if they're in a position to do so. But you've also got to look after yourself and think about yourself as well and your own lifestyle.

Well, absolutely. That's the that's one of the big things that that anyone in retirement when they're looking to gift money or looking to, you know, reduce the value of their estate so that they they pay less inheritance tax or their is pay less inheritance tax need to think about is to be careful not to jeopardize their own lifestyle in the process. They've saved hard for years and years and years to accumulate the kind of assets that they need to live comfortably and live the lifestyle they want. So it's really important to to bear that in mind. I mean, and that and that's where the planning aspect comes in because in in some cases, with the right prep, sort of right approach and right strategy, then you can sort of kill two birds with one stone.

You can reduce your inheritance tax bill, but also, you know, maintain your lifestyle in retirement and live the life that you want. But, yeah, I mean, that's why this next year is is is so important for so many people.

Craig, thanks for your time today.

Thanks for having me.

And thank you for listening to this episode of On The Money. Hope you've enjoyed it. If you've got an idea for a future episode or you have a question you would like one of the team to tackle, then please do get in touch by emailing otm@ii.co.uk for coverage of funds, pensions, and personal finance. Do go to the interactive investor website, which is ii.co.uk, and I'll hopefully see it again next week.