Inheritance Tax: Preparing for the Changes Ahead

Understanding your allowances, the upcoming pension changes and the options available to protect your family's financial future.

Inheritance Tax (IHT) is becoming an increasingly important consideration for many families. Estate values continue to rise, yet the allowances have remained frozen, bringing more people into scope than ever before.

With significant changes to the way pensions are treated for Inheritance Tax purposes coming into effect from April 2027, it's a good time to understand how the rules work, what is changing and what options may be available to help manage a potential tax liability.

The good news is that there are various ways to plan ahead. However, any planning should always take account of your own financial security and the lifestyle you wish to enjoy.

How much can you leave tax-free?

Under current rules, everyone has a standard Inheritance Tax allowance of £325,000, known as the Nil Rate Band.

There is also an additional allowance of up to £175,000 if you leave a qualifying main residence to children, grandchildren or other qualifying direct descendants. This is known as the Residence Nil Rate Band.

For married couples and civil partners, any unused allowances can generally be transferred to the surviving spouse or civil partner.

This means that, in the right circumstances, a married couple could potentially pass on up to £1 million without paying Inheritance Tax.

Anything above the available allowances is generally subject to IHT at 40%.

It's worth noting that the additional residence allowance gradually reduces for estates valued at more than £2 million, meaning it may not be available in full for larger estates.

These allowances are subject to qualifying conditions and other factors, including previous gifts and any available reliefs.

What's changing with pensions in April 2027?

One of the most significant upcoming changes to Inheritance Tax legislation relates to pensions.

From 6 April 2027, most unused pension funds and certain pension death benefits will be included within the value of an individual's estate for Inheritance Tax purposes.

Previously, many pension arrangements could be passed on to beneficiaries outside the estate for IHT purposes. This has made pensions an important consideration in estate planning, particularly for people who have accumulated substantial pension savings and haven't needed to draw on them during retirement.

Under the new rules, these unused funds will generally be taken into account when calculating any potential Inheritance Tax liability.

For some families, this could result in a larger IHT bill and a reduction in the wealth ultimately passed on to beneficiaries.

However, this doesn't mean you should rush to withdraw money from your pension or change your retirement plans.

Your pension is there to provide financial security throughout retirement. Decisions about withdrawals, gifting or changing pension arrangements need to consider your income requirements, tax position, investment strategy and longer-term plans.

The right approach will differ from one individual to another.

What can you do to reduce a potential Inheritance Tax bill?

There isn't a one-size-fits-all solution when it comes to IHT planning. Different approaches suit different people depending on their age, assets, income and family circumstances.

Some of the options worth understanding include:

Gifting during your lifetime

Giving money or assets to children and grandchildren during your lifetime can be one way of reducing the value of your estate.

Larger outright gifts will generally fall outside your estate for IHT purposes if you survive seven years after making them. These are known as Potentially Exempt Transfers.

There are also smaller gifting allowances available, which can be used as part of a wider gifting strategy.

It's important to remember that once you give money away, you no longer have control over it. You should always consider whether you can comfortably afford to make a gift.

Gifting from surplus income

If you have more income than you need to maintain your usual standard of living, you may be able to make regular gifts from your surplus income.

Under HMRC's normal expenditure out of income exemption, qualifying gifts can be immediately exempt from IHT, without needing to survive seven years.

There are specific conditions that need to be met, including that the gifts form part of your normal expenditure and leave you with sufficient income to maintain your usual standard of living.

This can be particularly useful for people with secure retirement incomes who would like to support children or grandchildren financially during their lifetime.

Trust planning

Certain trust arrangements can form part of a longer-term estate planning strategy, allowing assets to be held for the benefit of chosen beneficiaries.

Depending on the type of trust, the assets involved and the circumstances, this may help manage how and when wealth is passed on.

For example, investment bonds can sometimes be placed into trust, allowing you to plan for the future benefit of family members while retaining access to certain withdrawals, subject to the terms of the bond and trust.

Trusts are not automatically free from Inheritance Tax. Some transfers into trust can trigger an immediate tax charge, and certain trusts are subject to ongoing IHT charges.

Careful consideration is therefore needed before proceeding, and appropriate legal and tax advice may be required.

Life Insurance

Life Insurance can be another useful consideration for families who anticipate an Inheritance Tax liability.

A life insurance policy written in an appropriate trust can provide a lump sum to help beneficiaries meet a potential IHT bill following your death.

The aim is to provide funds when they may be needed, helping to avoid the need to sell property or investments to meet an unexpected tax liability.

The suitability and cost of cover will depend on individual circumstances, and premiums and policy terms need careful consideration.

Making use of your wealth

Sometimes, the simplest option is to enjoy more of your money during your lifetime.

Helping children onto the property ladder, supporting grandchildren or enjoying the retirement you've worked hard for can all be worthwhile uses of your wealth.

While leaving an inheritance is important to many families, it's equally important to make sure you have the financial freedom to enjoy your own life.

After all, you've worked hard to build your wealth, and it should benefit you as well as future generations.

Should you be doing something now?

Not necessarily.

For some individuals and families, Inheritance Tax planning is an important part of their overall financial strategy. For others, the priority should simply be ensuring they have enough money to enjoy a comfortable and financially secure retirement.

We would never recommend giving away capital, withdrawing pension benefits or changing existing arrangements purely to reduce a potential tax bill if doing so compromises your own financial wellbeing.

The important thing is understanding your position, being aware of the changes ahead and making informed decisions that work for you and your family.

At Wayne Austin IFA, we believe financial planning should be about making the most of your wealth during your lifetime, while giving you confidence about the legacy you leave behind.

If you have any questions about Inheritance Tax or would like to discuss how the upcoming changes may affect your financial plans, please get in touch with our team.