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A post-Budget example: Inheritance Tax

In the 2024 Autumn Budget, Chancellor Rachel Reeves announced that, from April 2027, pensions will form part of a person’s estate for Inheritance Tax (IHT) purposes.

We have put together an example scenario to illustrate how these changes could impact your financial plan.

Introduction

Pensions have previously been a staple of estate planning strategies, as they have offered a way to retain wealth outside of the estate for Inheritance Tax purposes.

Under the current proposals, this will no longer be the case from 2027. As such, it is important to begin considering how these could impact you and your current estate planning arrangements.

Setting the scene

Firstly, it is important to note that there is still no Inheritance Tax to pay upon the first death in a marriage or civil partnership for all transfers to the surviving spouse.

Additionally, if you were to die under the age of 75, whilst Inheritance Tax applies to the pension fund if it is passed to your children, there is no Income Tax charge on withdrawals. If you die after 75, the withdrawals will be Inheritance Tax and Income Tax-liable.

Further context is that within Nil Rate Band (NRB) rules for IHT, the first £325,000 of the estate is subject to 0% Inheritance Tax. This compounds to £650,000 in total for a married couple.

As for the Residence Nil Rate Band (RNRB), 0% Inheritance Tax applies to £175,000 per person if the home is gifted to direct descendants. As such, a married couple has £350,000 RNRB free of Inheritance Tax. Although, be aware that estates worth over £2m will be subject to the RNRB taper. This sees the RNRB reduced by £1 for every £2 over this limit.

Example scenario

To demonstrate the possible affects, we will analyse a married couple in their 60s who have children. They also have a mirror will – an arrangement where a couple has two wills that name each other as their beneficiaries, with a backup plan should they pass away in a common accident.

Their assets

AssetValue
Main residence£850,000
ISAs£500,000
Direct investment portfolio£200,000
Investment bond£200,000
Pensions£900,000
Total£2,650,000

Current tax position upon second death

AssetValue
Total estate £2,650,000
Less pension (£900,000)£1,750,000 (below £2m; no RNRB taper)
Less NRB (£650,000)£1,100,000
Less RNRB (£350,000)£750,000
Tax would be 40% on £750,000  =  £300,000 which is 11.32%

Potential tax under new rules (from April 2027)

AssetValue
Total estate £2,650,000 (above £2m; RNRB taper applies)
Less NRB (£650,000)£2,000,000
Less RNRB (£25,000)£1,975,000
Tax would be 40% on £1,975,000  =  £790,000 which is 29.81%

How can they reduce their Inheritance Tax liability?

As demonstrated by the tables above, the new rules pose a significant tax increase for the couple. With careful financial planning, however, there are several actions they can take to reduce their Inheritance Tax liability. Consideration of these options should be supported by a detailed analysis of income and expenditure requirements, along with cash flow forecasting. 

Possible solutions 

  • Gifting more of the pension to children and/or grandchildren upon the first death.
  • Taking any remaining tax-free cash and a reasonable level of income via income drawdown and gifting the excess.
  • Using the pension to buy a lifetime annuity.
  • Gifting money into trust.
  • Procuring life insurance/assurance that is paid out into trust upon the second death

If their financial plan allows for it, the couple may also be able to explore the routes below.

  • Investing in the Alternative Investment Market (AIM) – this is a sub-segment of the London Stock Exchange (LSE) for smaller, riskier, or high-growth companies.
  • Through specialist providers, investing in private companies since they can benefit from 100% Business Relief up to £1m in value.

Note: You should, however, understand that Business Relief investments are specialist, high-risk investments. Therefore, do not invest unless you are prepared to lose all the money you invest. Please consider these risks and, if you are concerned, get in touch if you would like to learn more before proceeding with this investment.

Preserving your legacy

Inheritance Tax and estate planning has always been a complicated area. It is not a pleasant subject to think about but meticulous financial planning is essential if you wish to leave a legacy for future generations.

Your circumstances are unique. As such, some of the options available to the couple in this example may not apply to you. On the other hand, more opportunities may arise as legislation continues to change. It is important to keep on top of this evolving area so that your beneficiaries are not left with an unexpected tax bill when you pass away.

A financial planner can give you the peace of mind that you are always on track to leave a legacy to your beneficiaries in the way you intended.

How can we help you?

Our expert team will take the time to fully understand your situation before providing solutions to any concerns you may have about the changes announced in the Autumn Budget.

If you would like to discuss your Inheritance Tax and estate planning options, or if you wish to arrange an initial no cost, no obligation, consultation, then please fill out the contact form below. Alternatively, you can call 01603 706 820 or email info@lffp.co.uk.

Important information

The contents of this article do not constitute financial advice.

The impact of taxation (and any tax relief) depends on individual circumstances. This has been prepared based on our current understanding of UK Law, Taxation and HMRC practice, all of which could be subject to change in future. The value of investments can fall as well as rise and it may not always be possible to receive back the sum initially invested. Past performance is not necessarily a guide to future investment returns.

While considerable care has been taken to ensure this information is accurate and up-to-date, no warranty is given as to its accuracy. This article constitutes a financial promotion.

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