“Don’t let the tax tail wag the investment dog” has long been a sensible way to approach financial planning. To follow this rule, selecting the most appropriate investment strategy, asset allocation and portfolio structure becomes the key decision to meet financial goals, with the tax consequences of any actions being of secondary importance.
With substantive changes to the tax landscape coming into force in April 2027, it is fair to revisit the accepted investment mantra to judge whether tax considerations will carry more weight in the future.
Pension considerations
From 6th April 2027, most unused defined contribution pension funds and lump sum death benefits will be added to the deceased’s estate for Inheritance Tax, leading to a tax charge at 40% above the nil rate band. This is now law, confirmed under the Finance Act 2026, which received Royal Assent on 18th March 2026. As a result of this significant change to tax legislation, many are being forced to rethink their long-term financial plans.
Since the introduction of Pension Freedoms, conventional investment planning advice has been to draw down on other assets first, as unused pension funds could be passed to beneficiaries on death without attracting Inheritance Tax. From next April, decisions on how best to draw retirement income will become more complex, with the interplay between potential Income Tax and Inheritance Tax liabilities being an important consideration. For example, drawing down pensions early to keep a pension pot out of an individual’s estate for Inheritance Tax purposes could lead to higher rates of Income Tax applying to the withdrawal itself, and loss of investment growth, which is tax-exempt while the investment remains inside the pension.
The more complex regime may well increase the appeal of annuities, where a pension is used to buy an income for life. A lifetime annuity without any guarantee will leave no residual value, thus avoiding any Inheritance Tax considerations; however, it may lead to higher rates of Income Tax being paid during a lifetime, and miss out on the potential for investment growth and flexibility that funds held in Flexi-Access Drawdown enjoy.
There can be no doubt that the tax changes from April 2027 will play an increasingly important role when selecting the correct path through retirement. The investment approach selected within pension savings, however, will remain critical to the success of any retirement strategy over the longer term.
Dealing with Capital Gains
Investors continue to enjoy broadly positive returns from investment markets, and investments that have been held for some time may well be carrying gains. Investments not held in a tax-efficient wrapper, such as an Individual Savings Account (ISA), Pension or Investment Bond, are subject to Capital Gains Tax (CGT) on disposal. To mitigate the impact, individuals receive an annual exempt amount of £3,000. If the total aggregate of gains, less losses, incurred in a tax year falls within the exemption, then no CGT is due. Gains above the exemption are taxed at 18% or 24%, with the rate applicable depending on whether the individual is a basic rate taxpayer or pays tax at higher or additional rate.
The annual exempt amount has been progressively reduced from £12,300 to £3,000 since 2023, resulting in CGT becoming increasingly unavoidable. Indeed, holding on to an asset purely to sidestep a CGT liability is a classic example of letting the tax tail take control, as this could lead to added concentration risk within a portfolio, and the lost opportunity to redeploy the sale proceeds into a potentially more productive investment. Furthermore, a gain on paper is not crystallised until the decision is reached to sell and holding on to an investment which then underperforms could erase the gains. A more sensible way to reframe a CGT liability is to consider that the investor gets to keep either 82% or 76% of the gains achieved.
Make the most of tax breaks
In addition to the changes to pension death benefits, the rate of Income Tax applying to savings and property investment income is set to increase by 2% from 6th April 2027, with investment income being charged at 22% (basic tax rate), 42% (higher tax rate) and 47% (additional tax rate). With the Personal Allowance and Personal Savings Allowances frozen, using annual tax-advantage wrappers, such as the ISA, will take on additional importance. Further planning, such as dividing assets between spouses to make sure all available allowances are used, is advisable. Using tax-advantage wrappers, that do not compromise the choice of investment strategy, spares the investor the choice as to whether to prioritise investment returns over the tax consequences of actions taken.
Personalised advice
It is increasingly clear that financial planning decisions will become more complex as we move into the new tax regime, and the tax consequences of actions taken will need to be considered carefully. As can be seen from the two examples covered in this article, the new tax rules for pension death benefits will require careful planning to avoid unintended consequences, whereas in the case of Capital Gains Tax, the long-standing convention of not letting tax dictate investment decisions remains true.
This growing complexity underscores the value of financial advice that weighs investment and tax planning together, rather than in isolation. As a Chartered, Independent firm, our experienced advisers can provide pension advice that models different drawdown strategies against both Income Tax and Inheritance Tax outcomes and show how Flexi-Access Drawdown, an annuity, or a blend of the two, could affect estate value and net income throughout retirement.
Where investments are held outside of a tax-efficient wrapper, our regular review service can help manage decisions that could lead to a CGT liability, by using the annual exempt amount each year or moving assets into a tax-efficient wrapper such as an ISA, to reduce future liabilities without abandoning sound investment strategy.
Speak to one of the team to discuss how the new rules could impact your financial plans, and actions you can take to enhance tax-efficiency across your pensions and investments.
