As the dust settles on the first Labour budget since 2010, it is apparent that the Labour government’s tax increases will be far-reaching. From a personal tax point of view, frozen allowances and increases to capital gains tax will have an impact, however the level of income tax and employee national insurance remains the same, and fundamentally nothing has changed from an immediate pay packet point of view.
However, the proposed pension death benefit changes are significant. When coupled with changes to inheritance tax reliefs, we are likely to see a big rethink of estate planning strategies going forward.
With pensions due to be brought into the inheritance tax firing line, and a reduction to the options available to mitigate this, an estimated 38,500 estates will be paying more inheritance tax in the tax year 2027/28 alone.
In this update, we’ll touch on what the changes in the budget mean for you, particularly focusing on what we believe to be the most seismic change to estate planning.
Hello, and welcome to our latest Insightful Planning with Astute video focusing on the recent Labour Budget. I’m Elliot Unsworth, Head of Client Proposition at Astute Private Wealth, and this video is the “part 2” of our post-Budget reaction, which, now that we have had time to digest Labour’s first budget, will hopefully give you some more detailed insights into some of the more significant plans that Labour have brought into play.
Stamp Duty
Whilst Reeves’ budget was over an hour long, that still wasn’t long enough to cover all of Labour’s planned changes.
There was a change to stamp duty in England and Northern Ireland that emerged as the dust settled. As an increasing base interest rate caused mortgage rates to spike (making buying a property with a mortgage less affordable), the Conservative government made temporary changes to stamp duty bands, essentially removing a 2% band and making it 0%. Due to this, currently, you don’t pay stamp duty on the first £250,000 of a property you are purchasing.
From 1st April 25, this 0% band will drop from £250,000 to £125,000, and above £125,000 to £250,000, being charged at 2%, so many more people will now be paying stamp duty. We are likely to see a push for home sales and purchases to complete before the next tax year is upon us.
In addition, the stamp duty surcharge, which is paid when purchasing a 2nd home, increased from 3% to 5%, effective from 31st October.
Capital Gains Tax
Let’s turn to Capital Gains tax. This is a tax on the profit you make when you sell certain assets for more than you bought them for. While the annual exempt amount hasn’t seen any further cuts and remains at £3,000, adjustments to rates mean that certain assets attract a higher tax burden when disposed of. The rate of CGT has increased from 10% to 18% for a basic rate taxpayer, and from 20% to 24% for a higher-rate taxpayer, both rates now matching those payable on residential properties (your main residence is exempt). It’s also worth remembering that a gain, when added to income, could tip an investor into a higher rate of tax. It was well telegraphed that Labour were likely to increase CGT, but the rates themselves were a surprise, given that they increased them by less than expected.
This change is immediate and will apply to any disposals on or after the 30th October. Whilst this means a higher tax burden on investors disposing of taxable investments, we don’t necessarily foresee this change affecting investor behaviours. Investors who have gains that aren’t held in a “wrapper” will continue to manage this by, for example, realising gains utilising their CGT allowance and moving assets into tax advantaged wrappers such as pensions or ISAs, by transferring their assets to their spouse to make full use of their joint allowances and/or potentially differing tax bands. Furthermore, other investors will realise a gain above their allowance because they need the capital. This behaviour will likely continue unabated, and the Government will simply see a higher tax take from this change. To be precise, the Government forecast an additional £90,000,000 to be raised in this tax year (even with us being halfway through!), rising to nearly £2.5bn in the tax year 2029/2030!
Frozen Allowances
The Personal Allowance and higher-rate tax threshold for income tax will remain frozen until 2028, at the current levels of £12,570 and £50,270 respectively. Although on the face of it, nothing here is changing, it is easy to overlook the impact this has over time – as inflation steadily makes goods more expensive, we expect to be paid more to maintain our standard of living. Our wages will grow, but the amount we can take tax-free will not, meaning that more tax is being paid, and the effect of this can be significant over the longer term.
These thresholds have been frozen since 2021 by the then Conservative government, and in 2022, it was announced that the freeze would be extended until 2028. However, Reeves had the power to thaw this six-year freeze early, but opted not to, stating that this would hurt the working people.
Harking back to the Capital Gains Tax changes mentioned before, since the rate at which you pay CGT depends on which tax bracket you sit in, this also means that more people will fall into the higher rate for CGT over time as their income creeps into the higher bracket through pay rises.
Inheritance Tax
Conceptually, nothing here has changed with the Inheritance Tax (IHT) regime; allowances remain frozen, and the rate of tax payable is unchanged. Now is a good time to remind you of the allowances available here. An individual can leave assets of £325,000 to their beneficiaries before becoming subject to IHT, and up to a further £175,000 if they leave their main residence to a direct descendant. Any unused allowances can be claimed by a surviving spouse, meaning that a married couple can essentially enjoy IHT allowances of up to £1M between them.
This second allowance, the “Residence Nil Rate Band”, begins to be lost once an estate value exceeds £2M at a rate of £1 for every £2 over £2m and, therefore, is lost entirely once an estate reaches £2.35M for an individual or £2.7M for a couple. This is known as the “Residence Nil Rate Band taper”.
Remember these details, as they become much more important when we consider perhaps the most significant announcement…
Pension Death Benefits
On the day of the budget, Rachel Reeves passed over this change in a matter of seconds as though it were a small afterthought rather than the fundamental shift to retirement savings it represents. From April 2027, the government propose that pension funds in their entirety should be considered part of an individual’s estate for Inheritance Tax purposes, whereas now most sit outside the estate and can be passed on free of Inheritance Tax. These proposals are forecast to raise close to an additional £1.5bn in the tax year 2029/30.
This change will bring a not-insignificant number of people into the IHT equation, with estimates of an extra 10,500 estates being subject to IHT from 2027, and almost 40,000 estates paying more tax as a result, with an average increased IHT bill of £34,000. This is especially true when you consider those who have been actively spending down non-pension assets to tackle their IHT issue while retaining sizeable pension funds in the background to be used essentially as legacy vehicles. For many individuals, this change is a nudge to spend their pensions in their lifetimes and gift their children’s inheritance to them now. Whilst most people would have already weighed up these decisions carefully, this shift to policy may now tip the scales for some.
It’s this behaviour – using a pension as a legacy vehicle – that the Labour government are actively trying to unwind, with their literature specifically stating that they want pensions to be returned to their previous purpose of saving for retirement by offering, effectively, tax deferral on earnings and tax-free growth. What do we mean by “tax deferral”? We’re referring to the mechanics of gaining tax relief when you pay in, and potentially paying tax on the way out, thus shifting any tax liability from now into the future.
So, a pension fund will become part of one’s estate and, thus, subject to IHT on death. Whilst this is under consultation, and so the facts could change before implementation in 2027, the silver lining (as we see it) is that, when reviewing the consultation document, the government would like any IHT due on a pension fund to be paid directly from the scheme; this would mean that the bill can be paid from pre-tax income, which reduces the burden somewhat. Another positive is that the spousal exemption will still apply, meaning a pension fund can be passed to a surviving spouse without triggering an IHT liability; this, however, is with the knowledge that it will eventually form part of the spouse’s estate.
These are the silver linings as we see them now… what about the clouds? To appreciate a “stealth tax” implication of this change, let’s revisit the Residence Nil Rate Band taper. With the inclusion of pensions in the estate, a lot more people are suddenly going to be caught by this £2m taper, effectively paying an IHT rate of up to 60% as a result, due to the mechanics of the residence nil-rate band.
This is likely to lead to a change in “death benefit nominations”; this is the instruction you leave detailing who you would like to receive your pension when you die. Let’s look at an example to bring it to life a bit more:
John and Jane each have a pension fund worth £1M, and own a home together valued at £700,000. If John dies and leaves his pension to Jane, and then she dies, her estate would be worth £2.7M; the Residence Nil Rate Band would be lost (as, remember, it is eroded away at a rate of £1 for every £2 over £2m), she could use her and her late husband’s IHT allowances totalling £650,000, meaning that £2,050,000 is subject to IHT, and the total liability is therefore £820,000.
However, what happens if John instead leaves his pension fund to their children on his death, on the basis that Jane would be able to comfortably live on the income from her own pension fund. On John’s death, his pension fund passes to their children and, since there is no spousal exemption in play here, the first £325,000 would be passed using his standard allowance, and the remainder would be subject to IHT of £270,000.
Jane would inherit the home and John’s unused Residence Nil Rate Band with it. When she died, her estate would be worth £1.7M but, importantly, not more than £2M. This means that she would be able to benefit from the full joint Residence Nil Rate Band of £350,000 plus her own allowance of £325,000. The IHT liability on Jane’s estate is £410,000. The total tax take, across both John’s and Jane’s estate, in this case, would be just £680,000. Compared to the first scenario, this is a saving of £140,000.
Indeed, further to this, we could see a rise in “spousal bypass trusts”, where the first to die leaves their pension fund to a Trust rather than an individual, preventing it from falling into the recipient’s estate, while possibly still giving the surviving spouse access. This is more complicated and would still only be suitable in a specific set of circumstances, but well worth mentioning.
There is another concern around the taxation of an inherited pension fund that has come out of these announcements. As things stand, if something happens to a pension holder before age 75, their beneficiaries can receive and access their inherited pension fund free of income tax. After 75, inherited pensions can still be accessed at any time, but income tax is due at the recipient’s marginal rate of income tax as and when any income is drawn. These rules were brought in in 2015 when a flat-rate death charge on pensions was replaced; however, all signs indicate that these income tax rules will remain in place.
What this means is that a pension fund could firstly be subject to IHT on death, and then the beneficiaries may have to pay income tax on anything drawn thereafter – effectively a double-whammy on the tax take, with effective tax rates as high as 76%! For context, a pension fund worth £41,900 could only be worth £10,056 net in the hands of a beneficiary if received as a lump sum (this maximum tax scenario is achieved through a beneficiary earning £100,000 before receipt, and the pension pot being subject to inheritance tax, and income tax, and the erosion of £12,570 personal allowance, which is eroded at a rate of £1 for every £2 over £100,000).
These implications are the reasons it is more important than ever to ensure that your pension funds are in a scheme which can facilitate all manner of pension death benefit options. The typical options available are to have the pension fund paid out in its entirety as a lump sum, used to purchase an annuity or switched to a pension fund in the beneficiary’s name. Although these options are available, not all schemes facilitate them, with the most common isolated option being the lump sum route, which is often the least tax-efficient.
A lesser-appreciated consequence of these changes is the impact they may have on the timescales involved in distributing pension death benefits. During a difficult time grieving the loss of a family member, financial worries are an unwelcome hassle. Pension funds do not fall under the remit of a person’s Will, which means you do not need to apply for Probate in order to have capital from a pension fund distributed; this has always been important because HMRC are currently quoting turnaround times of up to 14 weeks for granting probate applications.
Now, these changes do not bring the pension fund under the umbrella of Probate, but there will be a delay if the pension scheme administrators need to pay an IHT liability, as this would need to be done before funds can be distributed. In order to calculate the liability, the pension scheme would need to know the details of the wider estate, which can take a significant amount of time to pull together. There could be big delays when distributing pension funds compared to how things are now, and so leaving some accessible provisions for beneficiaries, possibly by way of holding money in a joint bank account, may need to be considered.
It is important to note that the proposed changes to pension death benefits are not due to come into force until April 2027, and a full consultation on the implementation of these new rules is currently underway and will last until January 2025.
The changes we have mentioned here mean that more assets from an individual’s estate will be brought into play when calculating inheritance tax due. Therefore, more individuals will be seeking to mitigate inheritance tax where possible. Pre-empting this, in the budget Labour clamped down on some of the options that are available to mitigate such liabilities.
Business & Agricultural Relief and AIM Shares
Changes in this area will have significant implications for certain investors. Business Relief and Alternative Investment Market investments are currently used as they attract 100% IHT relief once held for 2 years. Although this is not going away entirely, Labour will impose a combined limit of £1M on Business Relief and Agricultural Relief assets that qualify for 100% IHT relief, with only a 50% relief being applied over £1M. For AIM shares, the relief is dropping to 50% on all holdings (effectively resulting in a tax charge of 20%, not 40%); all of this will be effective from April 2026.
Whilst this change will certainly make Business Relief and AIM investments less attractive, since they still come with some IHT relief, they are unlikely to stop being used altogether; it may just be the case that investors only turn to the AIM market once they have maximised their Business Relief allowance rather than perhaps using the two in tandem as before.
This will likely see a rise in couples making sure to move money equally in their own Business Relief investments so that they both maximise their own £1M allowances. Interestingly, the £1M allowance will not be transferable between spouses. If a couple hold £1M each in Business Relief assets and then one of them dies and leaves this to the survivor, the survivor will hold £2M in Business Relief assets, only £1M of which would qualify for the 100% relief. To combat this, investors may deliberately leave their Business Relief assets to their children instead, thus utilising the allowance on first death and then again on second death.
We may also see an uptake in Deeds of Variation being implemented; a Deed of Variation is where executors of a person’s Will make changes to it retroactively, with the consent of all parties involved. These have to be filed within 2 years of death, and could be used to redirect Business Relief assets away from the surviving spouse.
For agricultural relief, these changes are a sting in the tail for family farmers who will now be penalised for passing on their livelihood to their children.
As you are coming to the end of watching this video, you may be thinking it’s all doom and gloom and that our pockets are just going to be a bit emptier in the future because of the increased tax burdens. However, it is important to remember that changes to tax rules are not new; the details will differ each time (different taxes and reliefs targeted by different amounts), although these announcements mean that this budget was definitely one of the more impactful budgets. But ultimately, we deal with changing legislation and regulation as a matter of course; it’s what we’re here for. These changes are likely to result in a tweak to your existing plan rather than result in any rug pulling from under you. It’s more important than ever to seek professional financial advice, and we are here to navigate you through the changes.
If you have the benefit of working with Astute, please reach out to your financial planner with any questions. They will help you to review your plan, discuss how the Budget impacts your goals, and explore strategies tailored to protect your wealth. If you are new to Astute, and would like to talk about anything discussed in this video, you can contact us on enquiries@astutepwltd.co.uk.
Thanks for watching, and we look forward to guiding you through these updates.
See you next time.
