Inheritance tax is one of the most unpopular taxes in the UK, as many people will pay 40% tax for the first time after they have died. The confirmation in the Budget that the IHT threshold of £325,000 will be frozen until 2030, and that any unused pension that is being passed on to beneficiaries will be included in the IHT net from 2027, has created a range of issues that should be addressed.
The basic IHT threshold is £325,000 with the Residence Nil Rate Band adding an extra £175,000 if you are gifting your home to a direct descendant. Yet despite this, IHT is increasingly catching those of us with more modest means, especially as they average house price in the UK is now £293,399 according to Halifax.
In fact, HMRC collected an additional £285m from IHT investigations in the past year to March 31, 2024, up 14% on the previous year. This is despite the number of investigations dropping by 4% in the same period.
However, some changes being brought in – including the need to include unused pension pots and farms that are being passed down through families – are causing consternation among those likely to be affected.
What is going to happen to farms?
Currently, if a farm is passed on to a younger relative, the transaction would pass free of IHT as the Agricultural Property Relief (APR) which applies to land, growing crops, farmhouses and the value of milk quota associated with the land, among other things and it currently has no limit. Items such as farm machinery and livestock would not be covered by APR but may be covered by Business Relief along with some of the other elements that make up a farming business. But from April 2026, APR and Business Property Relief (BPR) as it is referred to in the Budget briefing document, will be limited to £1m, and any amount above this would come into the IHT net, which could create a charge that would be very hard for the family to pay without selling the farm, or at least some of the assets to cover that cost.
From April 6, 2026, the combined 100% APR and BPR currently available for IHT would be reduced to 50%, so any amount over the £1m threshold would benefit from 50% relief for both APR and BPR, which would leave assets above this with an IHT charge. As IHT is charged at 40%, there could be a significant increase in the charges some farmers are facing.
There are ways to mitigate these costs, including taking out a life insurance policy which is written in a trust – which most life insurance companies will do without additional charge. It would also be possible to pass assets to the people you want to inherit them before you die. By doing this, and then surviving seven years, you would have removed these items from the IHT net.
However, you should not do this without advice. The Government has said it will bring in anti-forestalling measures from October 30, 2024, to April 6, 2026, which mean anyone making a lifetime gift and dying on or after October 30, 2024 and within seven years of the gift, the £1m APR will apply.
There has been a significant backlash from the farming community against these changes, and with some time before they come in, they could be removed altogether. If not, then these rules will apply from April 6, 2026.
What is happening when passing on pensions?
Those with defined benefit pensions are not typically able to pass on their unused pensions to beneficiaries. But those with defined contribution pensions can usually pass on their unused funds to their beneficiaries, and at present these are passed without any IHT liability.
However, what has been considered low-hanging fruit for some time now has finally been plucked by this Government, and from April 2027, these pensions will become part of the IHT net. But there are a few things you can do to reduce any IHT liability for the person who gets your pension.
For example, if you maximise your tax-free lump sum – which is 25% of your pension up to a maximum of £268,275 – then you can gift this to the person you would want to receive your pension on death. Surviving this gift by seven years will take it outside of the IHT net.
You can also take extra income out of your pension and give that away too. Regular gifts of money that you don’t need can be immediately free of IHT, but you will have to pay income tax on your pension income if you need to. You can also leave your pension to your spouse or civil partner, and because there is no IHT to pay between spouses or civil partners, this will enable you to pass it on without IHT becoming payable.
No matter what you choose to do, the most important thing is to ensure you have kept your nomination form up to date. Trustees have the discretion to pay your death benefits to the person you have nominated. So, any change in nominee from when you joined your pension must be updated to ensure the person you want to have your pension when you die is the person who actually receives it.
