Labour's Inheritance Tax and Pensions

What changes will labour make to inheritance tax?

Labour will freeze IHT thresholds until 2030, tax unused pensions from 2027, reduce Business Property Relief (BPR) for AIM shares to 50%, cap agricultural/business relief at £1m (50% above), and shift IHT to a residency-based system for non-doms from April 2025.

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Understanding the Changes

Traditionally, pensions have been a valuable tool for passing wealth to future generations without incurring IHT. However, the government’s decision to include pensions in the estate aims to address concerns about excessive pension savings being used as IHT avoidance vehicles.

Key Points:

  • Effective Date: The changes will take effect from April 2027.
  • Inclusion in Estate: Pensions will be added to the estate for IHT calculations.
  • Spousal Exemption: Pension death benefits passed to spouses or civil partners will remain exempt.
  • Consultation: A consultation period is planned to address anomalies and clarify rules.

Implications and Potential Impacts

The inclusion of pensions in the estate is expected to have a significant impact on IHT liabilities, potentially drawing more people into the IHT net.

Potential Impacts:

  • Increased IHT Liability: The value of pensions will increase the overall estate value, leading to higher IHT.
  • Loss of Residential Nil-Rate Band: Estates exceeding £2 million may lose the residential nil-rate band, further increasing IHT.
  • Impact on Defined Contribution Schemes: Defined contribution schemes will be particularly affected.
  • Potential Double Taxation: Income tax may be payable on pension withdrawals, followed by IHT on the remaining estate.

Planning Strategies

Given the upcoming changes, families should consider proactive planning to mitigate potential IHT liabilities.

Actionable Steps:

  1. Consolidate Pensions:

    • Consolidate multiple pension plans into a single, manageable plan. This simplifies administration and ensures accurate valuation for IHT purposes, preventing administrative burdens for families.

  2. Utilize Tax-Free Cash:

    • Withdraw the 25% tax-free cash and allocate it to a trust or family investment company.
    • Consider a flexible reversion trust, which allows access to capital.

  3. Family Investment Companies (FICs):

    • nvest tax-free cash into a FIC as a director’s loan, which can be withdrawn over time.
    • Gift the director’s loan to children, provided you survive seven years.

  4. Business Property Relief (BPR) Plans:

    • Consider BPR plans, which offer IHT relief.
    • Seek expert advice due to investment risks.

  5. Drawdown Arrangement:

    • Set up a drawdown arrangement and use gifts out of normal income rules to pass money to children.
    • Consider an insurance policy to cover potential IHT during the drawdown period.

  6. Seek Specialist Advice:

    • Engage with specialist advisors who understand both pensions and IHT.
    • Ensure advisors have experience with family investment companies.

  7. Plan Ahead:

    • Create a comprehensive long term plan that integrates pension and IHT strategies.

Key Considerations

  • Timing: Act now to plan before the 2027 changes take effect.
  • Documentation: Maintain thorough records of all transactions and valuations.
  • Flexibility: Be prepared to adapt plans as rules and regulations evolve.

By understanding these changes and implementing proactive strategies, families can effectively manage their IHT liabilities and ensure a smoother transfer of wealth.

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FAQ

When will pensions be included in Inheritance Tax calculations?
Pensions will be included in the estate for Inheritance Tax calculations from April 2027.
Are pension death benefits for spouses still exempt from Inheritance Tax?
Yes, pension death benefits passed to spouses or civil partners will remain exempt from Inheritance Tax.
What is the impact of including pensions in the estate?
Including pensions in the estate will increase the overall estate value, potentially leading to higher Inheritance Tax liabilities and possibly affecting the residential nil-rate band.
Why should I consolidate my pensions before 2027?
Consolidating pensions simplifies administration, ensures accurate valuation for IHT purposes, and prevents administrative burdens for families after your death.
What can I do with my 25% tax-free pension cash to mitigate Inheritance Tax?
You can withdraw the 25% tax-free cash and allocate it to a trust or family investment company. Consider using a flexible reversion trust for access to capital.
How can Family Investment Companies (FICs) help with Inheritance Tax planning?
You can invest tax-free cash into a FIC as a director’s loan, which can be withdrawn over time. Gifting the loan to children after seven years can remove it from your estate.
Are Business Property Relief (BPR) plans still beneficial for Inheritance Tax?
Yes, BPR plans remain beneficial, offering Inheritance Tax relief. However, seek expert advice due to investment risks.
What is a drawdown arrangement and how does it help with Inheritance Tax?
A drawdown arrangement allows you to take income from your pension and use gifts out of normal income rules to pass money to children. Consider an insurance policy to cover potential IHT.
Why is specialist advice important for planning around these pension changes?
Specialist advisors understand both pensions and Inheritance Tax, and can provide tailored advice. They also have experience with complex strategies like family investment companies.
What happens if my estate exceeds £2 million with the inclusion of my pension?
If your estate exceeds £2 million, you may lose the residential nil-rate band, which will further increase your Inheritance Tax liability.