The Inheritance Tax Timebomb: How Will It Impact Your Family?
The October 2024 Budget Announcements
The October Budget changes will impact estates from April 2026. However, it’s important to start planning now – in case the rules change further…
Business and Agricultural Property Relief will be subject to new limits from 6 April 2026.
Up until 5 April 2026 Business and Agricultural Property relief gives 100% exemption to IHT on business/agricultural assets.
Under the new rules every taxpayer will have £1m relief at 100%.
The excess property value will be taxable at 20% with the IHT payable over 10 years.
Note – the £1m relief is not transferable between spouses – so to obtain £2m relief each spouse must own a share of the relevant assets.
Tax planning
Review how family-owned property/shares are held and consider inter-spouse/family gifts of eligible property to increase the potential relief.
Unused Pension Funds – From April 2027 Subject to IHT
Unused pension/death benefits will become part of your taxable estate.
Fund administrators will be responsible for paying tax within 6 months of the date of death.
These provisions are subject to consultation but there are important planning points to consider now.
Tax planning
Review your existing pension plans – do they offer flexibility in choice of beneficiary – as some plans are very inflexible?
This is important as the beneficiaries will be taxed on income at their marginal rate (up to 45%) on top of the 40% IHT charge on the fund value.
Review plans for income drawdown at retirement and consider drawing income earlier – to reduce potential fund value at death.
Take full benefit from 25% tax-free at retirement.
Annuities will become more popular – particularly if rates remain at historically high levels (currently close to 10%).
Exemptions and Reliefs – Unchanged
Personal reliefs - £325,000 threshold plus £175,000 Residence Nil Rate Band – This means a married couple can pass on up to £1m tax-free.
Inter-spouse transfers remain exempt – but watch the risk of losing £500,000 relief on the 1st death.
Gift relief - £3,000 p.a. plus £250 per recipient.
Other reliefs for gifts in consideration of marriage and gifts out of surplus income.
Record keeping of gifts is essential – ideally use HMRC form 403.
Potentially Exempt Transfers – Unchanged
The 7 Year Rule exempts lifetime gifts made within the preceding 7 years. The potential IHT reduces annually as shown below:
0 – 3 years – Business assets 20%, Non-business assets 40%
3 – 4 years – Business assets 16%, Non-business assets 32%
4 – 5 years – Business assets 12%, Non-business assets 24%
5 – 6 years – Business assets 8%, Non-business assets 16%
6 – 7 years – Business assets 4%, Non-business assets 8%
7 or more – Business assets 0%, Non-business assets 0%
How Inflation Will Increase Asset Values
Asset values rise with inflation – a 3% rate of inflation on property and investment assets compounds to a 34% increase over 10 years.
A house worth £650,000 could be worth over £870,000 at 3% inflation p.a.
A £2m business ignoring the impact of real-term profit growth could be nearly £2.7m.
The Baby Boomer Generation
It’s clear to see that there will be a significant increase in the IHT tax take over the next 20 years – particularly as the Baby Boomer generation (born after 1945) pass away. Statistics published by Savills (2023) revealed that the over 50s now hold 78% of the UK’s privately owned housing wealth.
Review Your Will – Essential Planning
Now is the time to review wills in light of the changes announced. This needs input from your tax and financial advisors – as well as the lawyer drafting the will.
Common Law Spouses
Tax relief on inter-spouse transfers is only available to married couples or common law spouses. It’s not however available to couples who are co-habiting long-term.
Property Assets
Do you own property used in connection with your business?
If so, this will be subject to BPR rules – so potentially taxable at 20% rather than 40% on investment assets.
The excess over £1m will be subject to the 10-year Time to pay rule.
Where Will the Cash Come From to Pay IHT Liabilities?
Property owners are often asset-rich but cash-poor. There is an increasing risk that families will be forced to sell property at distressed values to meet IHT due on death. This is likely to cause significant distress at a very difficult time.
Tax Planning Points
Consider transferring taxable assets into a discretionary trust – where income can also be distributed to non-taxpayers (non-working spouses/children).
Look at Gift and Loan Back schemes – a more complex area but properly structured allows assets to be held outside the estate whilst the settlor can benefit from a loan back of capital. If planned for carefully the loan can be cancelled using the 7-year rule.
Wealth Preservation Trust – a sophisticated plan which allows trustees to surrender part of the gift annually to the settlor (Reversionary interest trust).
Look at discounted bonds – which offer the option to take 5% p.a. tax-free. This is a tax deferral – not exemption.
Finally – Note That There Is a Potential 20% Capital Gains Tax on Gifts Into Trust
Potential 20% Capital Gains Tax on gifts into trust – but this will only increase with inflation.
Gifts in excess of £325,000 will also be subject to the 20% lifetime IHT rate.