By Dale Critchley, Workplace Policy Manager, Aviva
For anyone advising individuals about pension saving, inheritance is becoming a factor that can’t be ignored. But is it something that can be relied on?
As the baby boom generation passes wealth to younger generations, the annual value of inheritances and gifts is expected to rise, culminating in what has become known as the "great wealth transfer". Much of this wealth has been accumulated through increases in house prices, but another substantial source of wealth is pension wealth. The most recent ONS data published in 2022[i] shows that housing makes up 40% of total wealth in the UK, while pension wealth stands at 35%, financial wealth 14% and 10% for physical wealth.
Baby boomer households may have benefitted from the accumulation of DB entitlements which represent a significant proportion of their overall wealth within official statistics[ii]. Unlike housing, investment portfolios and other financial assets, most DB pension wealth cannot be inherited and largely disappears on death. Where wealth is held in DC pensions, in most cases it will be consumed during a pensioner’s lifetime rather than passed on.
As a result, when pension wealth is included in official statistics, it’s important to remember that only part of that wealth is likely to transfer to future generations. The inheritances of younger generations will not include the DB wealth that has made the retirement of their parents and grandparents more comfortable and DC pension pots will be eroded by the withdrawal of income during retirement. For most people, what they inherit will be influenced, in the main, by housing equity and other assets.
Wealth in the UK is highly concentrated and inheritance will inevitably mirror that concentration. The IFS[iii] estimates that one fifth of people born in the 1980s have parents with wealth ‘per heir’ (i.e. after dividing it equally between their children) of less than £10,000, but 25% have per-heir parental wealth of £300,000 or more and 10% have £530,000 or more. The size of any inheritance will therefore vary greatly, exacerbating rather than reducing any disparity in retirement prospects within younger generations.
The uneven distribution of transferrable wealth means that inheritance is not a replacement for retirement saving for most, despite providing a potentially significant boost to those who do inherit. Those who don’t inherit, or who only inherit modest amounts, will remain heavily dependent on workplace or private pensions and the State Pension.
When assessing the likely value of an inheritance, it’s important to consider not only how much wealth can be transferred, but how much may be used up during retirement. Long-term care costs for example could erode assets such as housing equity. Housing equity may also be a source of pension income in later life, if DC pension pots are used up. Even where significant wealth has been accumulated, unpredictable future spending makes the value of any inheritance uncertain.
A focus on the role of inheritance in retirement saving is particularly relevant when we consider the age at which ‘heirs’ are likely to inherit. In the absence of earlier gifting, the IFS estimates that, on average, those born in the 1980s will see an inheritance in their mid-60s, with around one-third unlikely to receive their inheritance until their 70s [iv]. Inheritance is therefore more likely to supplement retirement income and fund later-life care costs, rather than providing help with earlier financial milestones such as getting on the housing ladder or accumulating a pension pot. Earlier gifting could change this somewhat, but with wealth tied up in pensions and housing this may not be a practical option.
While the pension system is designed around earnings, contributions and investment returns, over the next twenty years retirement outcomes might increasingly be shaped by what previous generations leave behind. That will improve retirement for some, but it also risks widening the gap between those who inherit wealth and those who do not. Inheritance can be a valuable addition to retirement planning, but it is too unequal, uncertain and often arrives too late to ever become a reliable substitute for saving.
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