Farmers took to the streets in protest following the agricultural relief changes in Labour’s budget. The implications of the proposed changes to pension death benefits and business reliefs are equally as significant for those who have spent the last decade organising their financial affairs. The latest budget is a rewrite of the rulebook, and unlike agricultural relief, which will be contained to a small, yet vital proportion of the UK, the severity of the changes to pension death benefits and business reliefs are yet to be fully appreciated.
In the final video in our IHT series, we delve into business relief, what you should now be considering doing with your pension, and why a whole-of-life policy may be an appropriate way to pay an IHT bill.
Hello, and welcome to the fourth and final video in our mini-series on Inheritance Tax Planning as part of our Insightful Planning with Astute videos. I’m Elliot Unsworth, Head of Client Proposition at Astute Private Wealth. In our budget reaction video back in November 2024, we covered the announced changes to pension death benefits and what it will mean for individuals from April 2027. As we await the outcome of the consultation on these changes, it is likely that they will come into force, and they are merely working out the smaller details at this stage.
Essentially, from April 2027, any remaining pension funds in your name will be included in your estate for IHT purposes, whereas right now most of them are not and are exempt from IHT. When you consider the fact that a lot of people have been using their pension fund specifically as a legacy planning vehicle, committing spare capital to it with no intention of using it to provide an income and earmarking their pension funds for their families, you can see why this change is so upsetting.
Before we get into the impact of this change and what you should consider doing about it, if you have the benefit of working with Astute and this video raises any questions, then please don’t hesitate to get in touch with your Astute financial planner. If you are new to Astute and would like to get in touch, we have created a link that sits below this YouTube video that will guide you to the right place.
Based on how we expect these changes to be applied, not only is this change to pensions likely to mean that more estates exceed the available Nil-Rate Band and will be subject to IHT, but for many, the inclusion of their pension in their estate will potentially see them subject to the Residence Nil-Rate Band taper that was outlined in video 1 of this series. The simple inclusion of the pension fund could see an individual become subject to an effective IHT rate of up to 60% as a result, whereas beforehand they may not have been liable to anything!
Right now, if you die before age 75, your pension fund can pass free of IHT and free of income tax to a beneficiary; by way of a lump sum, or the beneficiary can receive it as a tax-free pension fund in their own name. The latter option was usually always used because keeping the money as a pension fund would keep it outside the recipient’s estate, too. With the changes to the IHT treatment of pension funds, for most people, this preference for choosing one of the other will cease to exist.
If you die after 75, your pension fund becomes subject to income tax in the hands of the recipient. Interestingly, which is one word for it, this income tax treatment post-75 is to remain in place even once the IHT position has changed. This means that, if these changes come into effect, from April 2027, there will be a collision of income tax and inheritance tax, creating a perfect storm, with a potential tax charge of up to 89%!
So what can be done? We’re going to cover a few key planning areas that can be considered right away, as well as some that will help you looking forward.
Typically, a pension fund does not pass to your beneficiaries under the terms of your Will; it is dealt with by a separate set of instructions known as an “expression of wishes”. It is important to note that an expression of wishes is not a binding instruction, but it does help to capture your intentions.
Keeping this up to date has always been important, but now more so than ever. Firstly, to avoid the penal income tax treatment of a beneficiary receiving a pension fund as a post-age-75 lump sum (and all taxed as income in that tax year), you are going to want to make sure your beneficiary is named on the expression of wishes. This is because, as long as they are named, they may be able to receive the death benefit as their own pension fund and only pay tax as, and when, they access it. It is common for spouses to name each other on these, but less common to name children and grandchildren as backup beneficiaries; if you haven’t done this, now is the time to consider it.
Now is the time, for civil partners and married couples in particular, to consider whether your spouse actually needs your pension fund. Robust cashflow planning can help you determine this by exploring the survivor’s long-term financial position should part or all of the pension fund be removed from the picture. Should the conclusion be that the surviving spouse will never realistically need to access the inherited pension, it could make a lot of sense to only nominate the next generations.
Based on our understanding, there are 2 main reasons for this, ever-helpfully demonstrated by our favourite couple, John & Jane.
John and Jane’s estate is worth £1mn, plus John’s pension fund of £500,000, which he currently has nominated to Jane. John dies today, and his estate passes to Jane, along with all his unused allowances, and his pension also passes to Jane, exempt from IHT. Keeping all values the same, Jane then dies in May 2027, after the changes to pensions and IHT come into play. Jane’s taxable estate, now including the pension fund, is £1.5mn and her allowances are £1mn. This will result in a tax liability of 40% of £500,000: £200,000. Their children receive a net inheritance of £1.3mn.
Instead, let’s assume that John nominates their children to inherit his pension fund, which they can do as a pension fund in their own names. John dies, leaving his estate and his allowances to Jane, totalling £1mn. His pension fund passes to his children, exempt from IHT. Jane then dies in May 2027, but as her estate is within the available allowances, no IHT is payable. The children have received a net inheritance of £1.5mn and no tax has been paid.
The conclusion from these examples is that right now, before April 2027, when the rules change, pensions can be passed down the generations free of IHT. As such, if your spouse does not need it, it may be worth nominating your children until April 2027 so that no IHT is paid when they receive it. Otherwise, if your spouse receives it and then does not pass away for many years to come, the pension fund will become subject to IHT when it eventually passes to the children. Now, of course, this strategy is only applicable between now and April 2027, but given the process of nominating beneficiaries is signing a simple form – why wouldn’t you? You can always change it again later.
Indeed, if you happen to be in a situation now where a loved one has died, and you’re likely included in the expression of wishes, you may wish to consider making it clear to the scheme and trustees that you don’t need it, on the basis that it can pass down IHT-free now, whereas it might not in the future. Again, this is assuming you have engaged your Financial Planner to prove – beyond a reasonable doubt – that you can afford to give up this capital.
The second reason to potentially nominate a Trust or the next generation instead of your spouse is the impact that receiving a pension fund could have on their estate value. If a pension fund, when left to a spouse, results in total assets exceeding £2mn then the entitlement to the Residence Nil Rate Band could be impacted. Nominating a non-spouse, person or entity can prevent this, providing IHT savings of up to £140,000 by keeping two residence nil rate bands for a married couple; all by completing a simple form – the power of proper Financial Planning.
Owing to the tax legislation that has been surrounding pension funds for the last decade, for many individuals, it has been advisable to draw on non-pension assets to fund retirement in order to spend down IHT-able assets and preserve the exempt asset. Now that the IHT treatment of pensions is due to change, so will our advice and your behaviours.
It appears as though you will be able to draw an income from your pension fund that is deliberately surplus to your requirements, and then give it away under the Gifts out of Surplus income exemption that was mentioned all the way back in video 2 of this mini-series. As long as a pattern of regular gifting can be established and is genuinely surplus to your requirements, the money is immediately removed from your estate for IHT purposes. Such a strategy can be modelled extremely well by a comprehensive cashflow forecast.
You may be subject to income tax on these drawings of 20%, say, but the recipient of these gifts could fund their own pension with it, which could provide tax relief equivalent to the tax that you paid! This is an example of someone subject to basic rate tax, which, of course, could be higher or lower for you, based on your circumstances, and its effectiveness would depend on whether the recipient was able to put this much into a pension, depending on their own earnings and existing pension contribution arrangements, but it demonstrates the point. Even if they didn’t use the money to fund pension contributions, and spent the money enjoying themselves, if you are a basic rate taxpayer, you may have lost 20% in income tax, but saved 40% in inheritance tax, so still worth doing!
If you didn’t want to give the money away, you could still draw the income and spend it! Spending and enjoying your money is always going to be the most effective IHT mitigation tool available.
Generating a surplus income source from a pension fund can also be useful when considering one of the next planning options available to you – Life Cover.
“Whole of Life” cover is a policy for which you pay a regular premium that will pay out a lump sum when you die. This type of plan is an effective way of providing funds for your family to use to cover any IHT liability when it arises, particularly if your estate is “illiquid” (for example, all property or land, not easily accessible) and there is not much by way of accessible funds to pay the Revenue.
Life Cover does nothing to mitigate your IHT liability; however, usually it will pay out more money than you ever spent on the premiums, so there is a good return on investment there too – unless you live for a statistically exceptionally long time!
Care should be taken when arranging Life Cover because if done incorrectly, it can make your IHT liability even worse. Usually, it is recommended that the policy is written in Trust so that the sum assured is not paid to your estate when you die – otherwise it is subject to IHT.
As an alternative to Whole of Life, if you are also engaged in some IHT mitigation strategies that may see your liability reduced after, say, 7 years, you may wish to take out a “Term Assurance” policy. These are cheaper than Whole of Life plans as they only last for a set term, the idea being that the policy stops when your IHT liability disappears as a result of the planning.
And here we arrive at our final topic of this mini-series on IHT planning, which is Business Relief. Business Relief is an IHT relief of up to 100% that applies to certain qualifying assets after you have held them for 2 years. The most common ways of accessing this relief is through an “Inheritance Tax Scheme” or by investing in the Alternative Investment Market (AIM).
The major advantage of these schemes is that you only need to live for 2 years before your money qualifies for relief, as long as you hold them until you die. The downsides are the risks and the costs involved, and so we urge you to seek professional advice if you are contemplating using these; even then, typically, we would only suggest considering these if you have exhausted all other options available for mitigating IHT.
There are some key considerations when dealing with Business Relief:
Firstly, even once you have held assets that qualify for Business Relief for the required 2 years, although they may qualify for 100% IHT relief, and leave you with no IHT to pay, they still form part of your estate. This means that they will contribute to your estate when calculating your entitlement to the Residence Nil Rate Band, which starts to be lost once your estate exceeds £2mn – your Business Relief assets will count towards this. As such, it is often sensible to settle the assets into a Trust once you have met the qualifying holding period, which will remove them from your estate for the purposes of calculating the Residence Nil-Rate Band. There are no immediate implications to gifting business relief qualifying assets into Trust as this is an exempt transfer at the time of gifting.
Secondly, Labour announced that they would be introducing a cap on the assets one can hold in Business and Agricultural assets and qualify for 100% IHT relief at £1mn, with anything over that only attracting relief of 50%. For anything held in AIM shares, the 50% relief will apply straight away; no £1mn allowance here. This will all come into force in April 2026.
This does not mean that Business Relief Schemes will become obsolete after £1mn, because they still attract 50% IHT relief, which is more than any other strategy provides without giving your money away. This is just a change that we need to be mindful of, and can start to plan for.
And thus concludes our mini-series on Inheritance Tax planning in all its glory. It’s a complicated regime, with many complicated solutions which you may need in combination with each other, for example, a blend of outright gifts, utilising your allowances and protection, putting trusts into place and making use of business relief. As always, it is well worth seeking the guidance of an experienced, holistic Lifestyle Financial Planner to assist you in this area, and any other areas you need guidance on. We hope you have enjoyed our series on Inheritance Tax Planning.
We have had great and constructive feedback on our videos, and we would love for you to get the most out of them that you possibly can. If there are any subjects or burning questions that you would like a financial planner to answer, please leave them below this YouTube video.
Finally, remember that if you have the benefit of working with Astute and this video raises any questions, then please don’t hesitate to get in touch with your Astute financial planner. If you are new to Astute and would like to get in touch, we have created a link that sits below this YouTube video that will guide you to the right place.
See you next time.
