Published: February 2025
The Budget last 30 October introduced significant changes to the UK’s inheritance tax (IHT) framework, impacting on existing estate planning strategies for many individuals and their families, and bringing many more estates into the scope for IHT.
Key changes
From 6 April 2027, unused pension funds will be considered part of an individual’s estate for IHT purposes. Pension scheme administrators will be required to report unused pension funds and death benefits to HMRC and will be responsible for paying any associated IHT. The Government are still in the technical consultation period on the process required to implement these changes. Currently the rules are unchanged, and pension funds are still IHT exempt.
The rule change could impact on eligibility for the Residence Nil Rate Band (RNRB). The RNRB is an inheritance tax free allowance currently set at £175,000, which is available where an interest in a residential property is left to direct descendants on death, provided certain conditions are met. Any unused proportion of the RNRB can be transferred to a surviving spouse. Where an individual’s estate exceeds £2 million, the Residence Nil Rate Band (RNRB) is decreased by £1 for every £2 of the excess over and above £2 million. Therefore, if a surviving spouse with children has assets of £2.7 million or more, there is no RNRB available. The inclusion of pension funds in the IHT calculation for the purpose of the RNRB will not only introduce a potential 40% charge on these funds but it could also push more estates above the £2 million threshold, triggering a reduction in entitlement to the RNRB.
Tax relief on Alternative Investment Market (AIM) shares is currently 100% – this will be reduced to 50% relief with effect from 6 April 2026. This means that instead of being IHT exempt (after meeting the required two-year holding period), such investments will be subject to IHT at 20%.
IHT Thresholds have been frozen until 2030 which means the nil-rate band (£325,000) and the Residence Nil Rate Band (£175,000) will remain unchanged until April 2030. This prolonged freeze, extending the stagnation since 2009 and 2020 respectively, will inevitably result in more estates becoming subject to IHT over time.
Planning considerations
Saving IHT is a key concern for many but it is important this does not become the sole aim of planning. IHT mitigation is somewhat of a balancing act between saving tax and maintaining access to income and capital. Two of the simplest ways of mitigating/managing a future IHT liability are gifting/spending and insuring the liability.
Reduce your estate by gifting or spending. Reducing the size of your estate will help to reduce a future IHT liability. Gifts can either be made outright to friends or family or into trust for their benefit. Some gifts are immediately exempt from inheritance tax, so it makes sense to make these gifts first as they will have an immediate impact on any tax liability. Gifting may not always be possible, for example if the estate comprises of significant illiquid assets, such as a property portfolio. This is when ‘insuring the liability’ can be a suitable solution.
Insure the liability. After sensible planning, if there is still an IHT liability, it may be worthwhile using life insurance policies to provide a lump sum on death to cover the liability. This simplifies the estate administration by providing funds prior to probate to pay the tax due.
Life insurance can be particularly useful for families aiming to preserve the structure of their estates for future generations. Policies designed to cover IHT liabilities, such as Whole of Life policies, can ensure that beneficiaries receive a payout to settle any tax. This helps to avoid the need to sell family assets to cover tax obligations. Life insurance policies should be written in trust to ensure that the proceeds can be paid out tax-free. It will also ensure that beneficiaries have access to the funds immediately, avoiding the delays caused by probate.
Compared to gifting or complex trust structures, a Whole of Life policy can be a simpler and more predictable way to manage IHT exposure.
IHT planning is best dealt with holistically, taking into account all of your finances and goals. Professional financial advice should be sought to ensure all options are carefully considered and an effective strategy implemented in line with your personal objectives and goals.
If you would like to talk to one of our Chartered Financial Planners, please contact us on 01223 233331 or email info@mmwealth.co.uk.
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Disclaimer
Opinions constitute our judgment as of this date and are subject to change without warning. The value of investments and the income from them can go down as well as up, and you may not recover the amount of your original investment.
The information in this article is not intended as an offer or solicitation to buy or sell securities or any other investment, nor does it constitute a personal recommendation.
The Financial Conduct Authority does not regulate estate planning and tax planning.
The information contained within this blog is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change.
