In the recent Autumn Budget 2024, the Chancellor announced significant proposals to include pensions within the UK inheritance tax (IHT) regime. These changes are currently under consultation and are not yet finalised. If implemented, they will come into effect from 6th April 2027.
What Are the Proposed Changes?
Under the current rules, pensions are generally excluded from the value of an estate for IHT purposes. This means that pensions can be passed on to beneficiaries without incurring IHT. However, the proposed changes suggest that from 6th April 2027, most unused pension funds and death benefits will be included in the value of a person’s estate for IHT purposes. This could result in significantly higher IHT bills for many individuals across the country.
Impact on Different Scenarios
To illustrate the potential impact, let’s consider three examples:
1. Couples with Estates Below £1 Million Plus Pensions
Meet John and Mary. They have a house valued at £650,000 and savings & investments totalling £350,000, making their estate worth £1 million. Additionally, they have pensions worth £500,000. Under the current rules, they would not pay any IHT due to the Nil Rate Band Allowances of £1 million. However, from 6th April 2027, if the proposed rules are implemented, John and Mary would face an IHT bill of £200,000. This is because the combined value of their estate and pensions exceeds the Nil Rate Band, and the excess £500,000 would be taxed at 40%.
2. Individuals with Estates Below £500,000 Plus Pensions
Let’s consider Sarah. She has a house worth £450,000 and savings & investments worth £50,000, making her estate valued at £500,000. Additionally, she has pensions worth £250,000. Currently, Sarah would pay no IHT due to the Nil Rate Band Allowance of £500,000. From 6th April 2027, under the proposed changes, Sarah would face an IHT bill of £100,000. The combined value of her estate and pensions exceeds the Nil Rate Band, and the excess £250,000 would be taxed at 40%.
3. Couples with Estates of £2 Million Plus Pensions
Finally, meet David and Emma. They have a house worth £1.1 million and savings & investments worth £900,000, making their estate valued at £2 million. Additionally, they have pensions worth £1 million. Currently, they would pay IHT of £400,000. From 6th April 2027, if the proposed rules are implemented, David and Emma would face an IHT bill of £940,000. A significant proportion of this increase is due to the additional tapering of the residence nil rate band, which reduces the available allowance for larger estates.
The residence nil rate band (RNRB) is tapered for estates valued over £2 million. For every £2 that the net value of the estate exceeds this threshold, the RNRB is reduced by £1. In David and Emma’s case, their estate including pensions is valued at £3 million, which means they would lose all of their RNRB. This tapering effect significantly increases their IHT liability, contributing to the higher tax bill.
Please note that these examples assume that, where relevant, the estates qualify for the full nil rate bands and residence nil rate bands and use the relevant spousal exemption on first death.
Understanding Nil Rate Band Allowances
The Nil Rate Band (NRB) is the amount up to which an estate has no IHT to pay. The current NRB is £325,000 per person, and it will remain fixed at this amount until April 2028. Additionally, there is the Residence Nil Rate Band (RNRB), which is an extra allowance for those passing on their home to direct descendants. The RNRB is currently £175,000 per person, meaning a married couple can potentially pass on up to £1 million tax-free, combining both NRB and RNRB allowances.
However, the RNRB comes with certain conditions or “strings attached.” To qualify, the home must be left to direct descendants, such as children or grandchildren. If the estate is valued over £2 million, the RNRB is tapered away by £1 for every £2 over this threshold. This means that larger estates may not benefit fully from the RNRB, as seen in the example of David and Emma.
Next Steps
If you believe these changes may affect you, it is important to start planning now. There are many options available for IHT mitigation, including gifts out of income, direct capital gifts, and gifts into trust, which could potentially save hundreds of thousands of pounds in inheritance tax if implemented correctly. Please get in touch with us to discuss your specific circumstances and explore potential strategies to mitigate the impact of these proposed changes.
Please note that this article does not constitute formal, regulated financial advice nor a personal recommendation.
