What caught my eye this week.

The first few days of a new year are often an anti-climax. It turns out the problems we had last year aren’t magically wiped away by how human beings decide to formally turn a page.

However this time there’s déjà vu in the mix too. Because early 2025 has a distinct end of 2022 vibe.

Yes, bonds are selling off – and people are writing mean things about central banks and a UK chancellor again.

In fact, earlier in the week it was being framed with straight-up Truss-talk – another UK gilt crisis.

It’s true the UK is somewhat uniquely placed for bullying, being so enfeebled.

But rising yields are global, even if pundits in every country have tried to spin the rise in borrowing costs as their nation’s own special curse.

Here we’re blaming Rachel Reeves’ tax-raising and spending budget.

In the US people point to incoming Trump tariffs and a government deficit in the trillions continuing to add to its planet-sized national debt – as well as a growing conviction that inflation isn’t quite licked.

But yields are up in Europe too – in the EU and outside of it.

For example in Romania – where the ten-year yield is nearing 8% – I suppose they’re blaming their own barmy strongman moment.

It’s different this time

As often happens with bonds, trouble was brewing for months before it landed on the front pages.

Financial nerds (guilty) were especially worried by the unusual development illustrated in this graph:

As Torsten Slok at Apollo wrote when he posted it:

The market is telling us something, and it is very important for investors to have a view on why long rates are going up when the Fed is cutting.

By the end of the week – when the US posted a surprising high ‘jobs number’ that showed the economy was firing on most cylinders – the consensus was that the ‘terminal rate’ was going to end up higher, and that this was what the clever market had already discounted.

Terminal bore

The ‘terminal rate’ is just bond-wonk talk for where they expect rates to end up for the five minutes when everything is in balance, before the next crisis strikes and central banks have to act again.

Six months ago everyone was looking forward to multiple rate cuts from the US Fed. And many were still wondering where the long-promised recession had gone.

So yields seemed dead set to fall.

But looking at markets now, I’d be surprised if even the one Fed cut still expected comes to pass this year.

Of course, saying “yields are up because the terminal rate is higher” really just palms off the question of “why?”

As does another bit of bond jargon that I think is relevant – the ‘term premium’.

This term premium is basically the extra return you’d expect and demand for buying long-dated bonds instead of short-term bonds.

But without getting into the weeds – and knowing full well that some readers will confidently declare they know exactly what it is in our comments – let’s just say the term premium is a bit controversial.

That’s because it involves estimates of risk, not simple maths. (Some people even deny it exists!)

It’s a mad-a world

The sober way to assess the graph above is to say that the US economy is much stronger than was expected, inflation has been largely dealt with but is still over-target for the usual laundry list of reasons, and that Trump will cut taxes, boost growth, and continue to add to the US national debt.

However I’m minded to agree with economist Paul Krugman, who speculates there may now be “an insanity premium on interest rates”.

Krugman writes:

Look at the dynamic over the past few days.

Jeff Stein of the Washington Post reported that people around Trump were planning a fairly limited, strategic set of tariffs rather than the destructive trade war against everyone Trump has been promising; Trump quickly responded with a Truth Social post calling the report “Fake News” and declaring that he does too intend to impose high tariffs on everyone and everything.

In short, Sources: “Trump isn’t as crazy as he looks.” Trump: “Yes I am!”

Then, as if to dispel any lingering suspicions that he might be saner than he appears, Trump held a press conference in which he appeared to call for annexing Canada, possibly invading Greenland, seizing the Panama Canal and renaming the Gulf of Mexico the Gulf of America.

This morning CNN reported that Trump is considering declaring a national economic emergency — in a nation with low unemployment and inflation! — to justify a huge rise in tariffs.

Like any economist Krugman has been wrong about plenty of things, but I think he’s on the money here.

I’d even argue there’s some kind of Stockholm Syndrome thing going on in US politics at the moment, which has reached across the pond to us too.

A man who early last year was found guilty on 34 counts of falsifying business records to disguise hush money payments to a porn star has been re-elected as President for a second term.

You may recall the headlines:

Trump is the first ex-president to be sentenced for criminal conviction.

Yet this week he wasn’t given anything for his crimes – basically because he’s about to be a President again and nobody wants a fuss.

No fuss, like, say, that we saw four years ago when his followers run rampant through one of the US government’s most important buildings and multiple people died:

If you think this is all normal then good luck to you.

Indeed even if you’re one of his Poundshop fans stirring up trouble on social media this week – someone whose knowledge of history doesn’t seem to extend beyond The Battle of Britain – then you have to admit that for good or ill, things seem to be ‘in play’.

Just since Krugman’s recap we’ve had the MAGA wing blaming the L.A. fires on excess wokeism. As opposed to, say, last year being the hottest globally since records began due to human-induced climate change.

And now I read Peter Thiel opining in the FT and calling for a Truth and Reconciliation process in which US state secrets are declassified by Trump to the world because “the Internet won”.

Meanwhile Trump’s best-buddy and backer Elon Musk is getting stuck into politics here, in Germany, and elsewhere. And the same faction of Tories who clutched their pearls when Obama suggested Brexit didn’t make a whole lot of sense eagerly leapt up with their tails wagging and teeth drooling when this foreign master called.

You can obviously see my biases here – but it is all relevant for the bond market.

In the first Trump presidency we saw yields roiled by his random Tweets. Such uncertainty has a cost.

In short, bond holders want more of a return when they’re hostage to a self-proclaimed revolution, and I am pretty sure that’s reflected in the escalating term premium

Back in basket-case Britain

US bonds matter because they act like gravity on yields around the world.

If you can get 5% on 20-year US Treasuries – which you now can – then it’s harder to justify owning say European government debt on lower yields, let alone that of an emerging-emerging market like the UK.

The UK 30-year gilt yield is now 5.4% – up from a yield of 5.1% when we sang Auld Lang Syne and just 4.3% back in September.

That’s a huge move.

Mostly this reflects rising yields across global bonds, but the UK does seem to be getting it a bit worse.

Sure, the Budget won’t have helped. I didn’t like Labour’s anti-growth tax on business either.

True, blaming the new Labour government for coming clean on the mess left by the previous 10-plus years of unavoidable events – Covid, Ukraine – and witless self-harm – the ongoing cost of Brexit, which more or less covers the spending gap Reeves is trying to fill – seems to me like chastising the parents who are cleaning up a ruined house after a teenage party goes viral on Facebook.

But that’s democracy. He or she who who’d wear the crown must drink from the poisoned chalice.

And on that note – not incidentally – we have Nigel Farage and Reform waiting in the wings and polling a 20% share of the popular vote.

When you consider the best that can be said about Brexit is house prices didn’t immediately crash – but absolutely nothing good came of it, not even the all-important fall in immigration – then you can see the problem.

As in the US, some people are still voting with their hearts and feelings, not their heads.

In such a climate anything can happen. And with UK government borrowing now looking like rising and becoming more costly to service even with grown-ups in charge, I can well understand why a bond holder would want more return for holding a 20-year bond baby.

(Bigger picture: how’s your bug-out emergency plan coming along?)

Inflated expectations

With all that out my system, let’s also admit higher yields are about inflation expectations, as I said.

True, this is undoubtedly linked to politics too. The timing in Torsten’s graph above makes that clear. Non-token tariffs and mega-deportations would cost the US economy, and hurt the rest of us too.

But just on the numbers, inflation hasn’t yet returned to target in the US and most other places, and the big US jobs number won’t have settled any nerves.

Personally I don’t understand the surprise.

Just 18 months ago, confident sages were telling us we’d need a recession and soaring unemployment to bring down the double-digit inflation.

In fact we needed neither – probably because double-digit inflation was yet another hangover from the pandemic, more than anything normally cyclical – but I’m not surprised it’s lingering on above 3%.

I was warning here as far back as 2020 that the aftershocks from global lockdowns would reverberate for years, like a cranky old machine you turn off and restart. It was never going to be a painless reboot.

But how much does a little bit of ongoing inflation really matter, anyway?

Inflation targets are arbitrary, and while it would do more damage to abandon them here, the Fed and other Central Banks can probably quietly ignore them if they believe inflation will still eventually settle, if they’d rather keep the economy humming. Especially when inflation expectations seem anchored, and in the main the big demands for huge pay increases have gone away, at least outside of the public sector.

Alas, the trouble, as I’ve belaboured above, is that political and fiscal events are rocking that quiet agenda.

The bond scare and you

So what does this all mean for our personal finances?

Well, mortgages probably aren’t going to get cheaper anytime soon.

Even if the UK does go back into recession, the Bank of England can’t really cut much against wider rising yields. Besides, it’s that market rate environment that really sets mortgage rates.

Higher government borrowing costs could well mean more taxes, too. Goodness knows from where.

And/or spending cuts – but ditto.

On a brighter note savings rates should stiffen a bit. Good news for those with a stash of cash.

The 60/40 sitrep

Another thing worth mentioning is that bond portfolios won’t be feeling anything like as much pain as in 2022.

Yes you’ll probably be looking at capital losses rather than the gains that seemed likely a year ago. But check out this five-year graph:

Source: Google Finance

The recent declines in iShares’ core long-term bond ETFs are not pretty, but they’re nothing on the scale of what we saw in 2022.

As I’ve stressed a few times over the past couple of years, the dramatic re-rating of bonds from the near-zero era was a one-time massacre that shouldn’t put you off the asset class for life.

If your preferred asset allocation wants them in your portfolio, then you needn’t overly-fear a repeat of 2022. Or at least if we saw another 2022 in a hurry then we’d have problems that would roil everything else in your portfolio except perhaps for gold and tins of beans.

Finally, I presume those of you who believe that holding individual long bonds would somehow have saved you from the murderous maths of the 2022 bond sell-off will finally listen to me when I say that it wouldn’t have.

Here’s how the Treasury 4.5% 2042 gilt has behaved over the past three months, for instance:

Source: Hargreaves Lansdown

And here’s the five-year chart:

Source: Hargreaves Lansdown

As the second chart shows, own expensive bonds trading above-par and you’ll get whacked when yields rise, whether you hold the bonds individually or in an ETF that makes the job easier for you.

There are other reasons you might prefer to own individual bonds. But I see so much confusion in the comments about it that I think it needs its own article. For now know that reducing duration is the only way to prevent this kind of short-term volatility (typically at the cost of long-term returns).

The bond news signal

I’ll leave you with a hopeful thought.

Normally when ever-boring bonds make headlines around the world, we’re near or even past the peak of things getting worse.

So I imagine yields will steady from here. At least for a while.

Have a great weekend!

[continue reading…]

We’ve been challenged by pension planning on Monevator before. In particular you may recall my previous post on a fictional middle-class duo, Sarah and Stephen, and their pensions-and-IHT-planning saga.

Near the end of that piece, I read the vibes coming from the presumed shoe-in of an incoming Labour government and confidently declared:

Nor do I think it’s likely they bring pensions into people’s estates.

Pensions are trusts, and this would require the overhaul of quite a bit of trust law.

Well, chalk this up as another episode in the long drama of Finumus Predicts Poorly.

And let it serve as another reminder not to take anything as anything as gospel from semi-random internet pundits. Me included!

That said, I did hedge my bets in a later article, warning:

Over the long run, I doubt ‘beneficiary’ pension pots compounding tax-free for decades will survive the ‘Someone has £1bn in their pension’ headlines. We’re not America.

But I didn’t think the unravelling would come this quickly…

Pensions join the IHT parade

Starting April 2027, defined contribution (DC) pensions will fall within the scope of inheritance tax (IHT).

While the exact legislation is still to be hammered out, let’s assume the worst. (Generally the best approach to tax policy, especially for cynics).

Labour’s moving of the goalposts is not just a headline grabber. Bringing DC pensions into the scope of IHT creates significant problems, especially for those who’ve been diligently building retirement savings to double as intergenerational wealth vehicles.

Let’s have a quick refresher on how the system presently works.

The (simplified!) current rules:

1. Pension assets are outside your estate for IHT purposes.
2. On death, assets inside your pension can be passed to beneficiaries, as per your Expression of Wishes.
3. If you die before 75, beneficiaries can withdraw tax-free (but they don’t have to – they can instead let the pot grow indefinitely).
4. If you die after 75, beneficiaries pay income tax on withdrawals, but no IHT.

This structure has long been a favorite of tax planners for IHT minimisation.

Combining generous tax relief on contributions with tax-deferred growth and IHT-free transferability? It’s a potent cocktail – akin to having your cake, eating it, and then feeding it to your heirs in perpetuity.

But come April 2027, the party’s over.

The New World Order

Under Labour’s proposed new rules:

• Pension pots will face 40% IHT.
• Beneficiaries will also pay income tax on withdrawals, regardless of the original owner’s age at death.

One or the other might have been tolerable.

But both? It’s brutal.

[Editor’s note: The early consensus from Monevator readers is that Finumus’ worst-case scenario is excessively fatalistic. The suggestion so far, they note, is that the income tax regime on inherited pensions will remain the same. This would mean no income tax if the donor dies before age 75. We will not know for sure, of course, until we see the proposed legislation. Please read and add your own thoughts in the ​comments​.]

To illustrate why Labour’s new rules could be so tough, let’s compare some outcomes.

If you start with £100 in a pension, under the current system, your descendants can keep that £100 compounding tax-free forever (as long as they never draw it down).

What about under the new system? Well, that same £100 shrinks to mere pennies over five generations due to compounding taxes.

Changing the rules like this effectively introduces a wealth tax of ~1.33% per year on assets in pensions.

And unlike other assets, pensions are trapped. You can’t give them away to sidestep IHT – or at least you can’t without paying income tax.

I feel another meme coming on…

Meet the victims: Sarah and Stephen

Let’s revisit our fictional friends from my previous post, Sarah and Stephen.

The doughty duo were last seen convincing Sarah’s parents to fund their pensions to the tune of £360,000 to save both IHT and to give them a bit of financial breathing room.

Since then:

• Sarah successfully squeezed £360,000 (gross) into their pensions.
• Their kids, Amelia and Jack, are now at university.
• Stephen netted £1 million from a venture investment.
• Their ISAs and SIPPs have soared in the bull market.

Their net worth (including gross value of pensions) now sits at £7.3m.

If they die tomorrow, their estate would owe £1.58m in IHT. But if they die post-April 2027? That IHT bill balloons to £2.7m. That’s an extra £1m gone to HMRC.

Dinner table drama: a clash of generations and expectations

Over dinner, Sarah unveils the grim numbers to Stephen, her spreadsheet glowing ominously on the kitchen table. Stephen’s initial reaction is one of stoic resignation.

“The kids will be fine,” Stephen says, sipping his wine. “We’ve given them a great education, a leg-up most people can only dream of. They’ve got to stand on their own two feet eventually.”

Sarah isn’t so sure: “Fine? In this economy? You have remembered that they are both studying humanities?”

Sarah reminds him that the cost of housing has ballooned since their own days as scrappy young professionals.

“Even with decent jobs, Amelia and Jack will struggle to buy a home in London unless we help,” she argues. “Add in student loans, higher taxes, and the cost of living – they’ll be working harder for less. And now, a good chunk of what we planned to leave them will be eaten by this new pension tax double-whammy.”

Stephen sighs but doesn’t counter. Sarah has a point. Their £2.7m post-2027 IHT bill could be as much an entire post-tax career’s worth of income for their kids.

That stark figure prompts Stephen reconsider his laissez-faire attitude.

“It’s not about leaving them a pile of money to blow on avocado toast and electric cars,” Sarah presses. “It’s about giving them options – the same options we’ve had. Financial freedom and choices. Security.”

By the end of the meal (and a bottle of wine), the conversation has veered from pragmatic planning to a lamentation of modern Britain.

They reminisce about the 1990s – lower taxes, cheaper houses, rising wages – and wonder how it all went so wrong.

“We’re not just managing money here,” Sarah concludes, a bit teary-eyed. “We’re managing their future.”

A camel through the eye of a needle

As Sarah digs into spreadsheets, she realises their pensions will need to be spent down – flipping their previous ‘pensions-last’ strategy on its head.

This will actually be quite difficult, she discovers as she runs the numbers.

For simplicity, Sarah bundles their SIPPs together and assumes both her and Stephen retire at 55, die at 85, enjoy smooth 3.5% returns, and make no further contributions to their pensions:

If they limit withdrawals to paying basic rate tax, then they’re not going to get it all out.

If they are prepared to go to take a 40% hit though, then maybe they can:

Stephen points out that 30-year gilts have a 5% YTM right now, so Sarah’s 3.5% return assumption is a bit pessimistic. So she plugs that in. 

Yeah, they are not going to make it.

They should probably just assume that they’re going to have to pay 45% to get it all out at some point.

What’s the new plan?

For now the couple will:

• Only make further pension contributions if they can effectively achieve at least 50% tax relief. (For example income taxed in the 60% band, or with Employer’s NI via Salary Sacrifice). 
• Think about retiring earlier than they otherwise would have.

And in retirement they’ll:

• Prioritise running down pensions as soon as they retire.
• Gift assets from their ISAs and other holdings to reduce taxable estate.

The generational headache: from one tax trap to another

The pension changes don’t just complicate Sarah and Stephen’s plans. They cascade upstream to Sarah’s parents and downstream to her children.

As the family’s de facto CFO, Sarah realises she has to juggle three generations of financial puzzles, each affected differently by these changes.

Sarah’s parents, Mike and Mary, are in their early 80s. Their SIPPs are smaller, but still substantial enough to pose problems.

Sarah’s immediate focus is to get Mike and Mary drawing down as much as they can while staying in the 20% income tax bracket.

“Every pound we can get out now saves Amelia and Jack from paying 40% IHT plus income tax later,” she explains to her increasingly confused parents. “It’s simple maths!”

Then there’s the tricky issue of skipping a generation.

If Mike and Mary’s pensions pass directly to Sarah, they’ll fall into her estate, creating a tax nightmare. To avoid this, Sarah gets them to update their ‘Expression of Wishes’ forms to redirect those funds to Amelia and Jack instead.

But even this has its pitfalls.

“The kids could inherit £420,000 each in their early 20s,” Sarah frets. “That could either set them up for life – or ruin their work ethic.”

Sarah tries not to think about what will happen when their children’s children face the same tax quagmire.

Pensions as poisoned chalices?

As Sarah continues crunching the numbers, she starts to question everything she thought she knew about pensions. What was once the family’s golden goose – a tax-efficient savings vehicle and inheritance tool – now looks more like a poisoned chalice.

Let’s take Amelia’s hypothetical future. By 2030, thanks to Sarah’s strategic planning, both children each inherit sizable SIPPs – say about £600,000 each, boosted by earlier contributions. These balances are enough to provide financial security, but the tax implications loom large.

For example, there’s going to be little point in Amelia making pension contributions once she starts work. (Unless it’s to avoid marginal tax rates of 20,000%.)

If Amelia doesn’t add another penny to her pension but lets it compound at a conservative 3.5% for 35 years, it grows to £2m. At 5%, it hits £3.3m.

A fantastic outcome on paper, clearly. But when Amelia eventually withdraws funds, she’ll face income tax at higher rates. And since she can’t leave her pension untouched for her children (thanks to the new IHT rules) she’ll be forced to draw it down aggressively or see it taxed again upon her death.

This realisation leads Sarah to stop contributing to her children’s SIPPs altogether.

“What’s the point?” Sarah laments. “All we’re doing is building them a tax headache for the future.”

Sarah looks at all this in despair, and she honestly doesn’t understand how this can be not ‘raising taxes on working people’.

She starts to wonder: how bad can five years in Dubai really be?

What do you think?

We’d love to hear what people think of Sarah’s situation. In particular, some practical tips amongst the outpouring of sympathy – or otherwise – would be most welcome.

I’m going to be coming back to wider IHT planning options for Sarah in future posts, and I’ll doubtless be covering: gifting rules, trusts, life insurance, life assurance, family investment companies, and possibly at this rate, emigration. I might even talk about (gulp!) annuities

Of course there’s also policy risk to consider. Sarah might retire early, start aggressively drawing down her pension, pay tax on it, and then see a 2029, Farage-led, Reform / Tory coalition government abolish IHT on its first day in power.

Want to add something to the discussion? You know where the comment are…

Be sure to follow Finumus on Bluesky or X and read his other articles for Monevator.