In the Autumn Budget on 30 October 2024, Rachel Reeves introduced several significant changes to inheritance tax (IHT) rules, requiring many families to rethink their succession plans. While farmers have voiced their objections, the announced changes will have far-reaching consequences for estates, particularly those with substantial assets.
Current IHT Rules
Under existing inheritance tax rules, the value of an estate—after deducting debts such as mortgages and qualifying tax reliefs—is subject to IHT when someone dies. However, if you’re married or in a civil partnership, you can leave unlimited assets to your spouse or partner without triggering an IHT liability. This effectively defers the IHT until the second death.
Everyone has a nil-rate band (NRB) currently set at £325,000. This NRB will remain frozen until 2030 despite the fact that it has not been increased since 2009, meaning it hasn’t kept up with inflation. However, transferring any unused NRB to your surviving spouse is possible, effectively giving the couple a combined NRB of £650,000.
There is also a residential nil-rate band (RNRB), an additional allowance of £175,000 per person for estates under £2 million, provided the property is left to direct descendants (e.g., children or grandchildren). A married couple could, therefore, have a combined IHT-free allowance of £1 million. However, once the estate exceeds £2 million, this allowance begins to taper down.
Exempt Assets
Not all assets are subject to IHT. The main exempt asset is your pension pot, which passes free of IHT to your spouse or children, provided you have the correct nominations in place. For pensions that have not been drawn down by the time of death, there is no IHT liability, but income tax may apply when the beneficiaries eventually access the funds, particularly if you were over 75 at the time of death.
Agricultural Property Relief (APR) and Business Property Relief (BPR)
Two key reliefs that impact IHT planning are Agricultural Property Relief (APR) and Business Property Relief (BPR). APR currently offers 100% relief on agricultural land, enabling farmers to pass down their farms without incurring an IHT bill. To qualify for 100% APR, the land must be actively used for farming purposes, such as growing crops or rearing livestock. However, the relief is more limited when it comes to farm buildings. For instance, the farmhouse must be of a size appropriate to the farming activity, meaning large manor houses surrounded by farmland are unlikely to qualify.
In some cases, the land’s value exceeds its agricultural value, prompting a claim for BPR as well. BPR offers 100% relief on shares in unquoted trading companies, provided the business is not primarily involved in property investment. However, recent changes have made the rules more complex, especially since the pandemic. For example, businesses that diversified to survive or entered joint ventures may no longer qualify for full BPR if their non-trading activities exceed their trading ones.
Changes in IHT Rules: What You Need to Know
Reeves’ budget announced three major changes to IHT rules that will come into effect in the coming years:
o Pensions to be included in the IHT net
From April 6, 2027, any unused pension funds will be treated as part of an estate for IHT purposes. This applies to both defined contribution and defined benefit pensions. The pension scheme administrator will be responsible for IHT reporting and tax payments.
o Cap on APR and BPR relief
Starting from April 6, 2026, the 100% relief available on APR and BPR will be capped at £1 million. Only 50% relief will apply for estates exceeding this amount, effectively creating a 20% IHT liability on the value over £1 million.
o IHT to be based on residency, not domicile
From April 6, 2025, the UK will move to a residency-based IHT system, replacing the previous domicile-based approach. This means that individuals who have been UK residents for more than 10 of the past 20 years will face IHT on their worldwide assets. Conversely, expatriates who have been non-residents in the UK for over 10 years will only be subject to UK IHT on UK assets.
Example of the Impact of IHT Changes
Let’s consider an example of a husband and wife with a £1.5 million home and a £1 million pension, giving them a total estate of £2.5 million.
- Under current rules, they would have an IHT liability of £200,000 since their pension is exempt from IHT, and they would benefit from two NRBs and an RNRB.
- After April 6, 2027, their liability would rise to £740,000, with £296,000 payable by the pension trustees and the remainder from the estate. This increase in IHT is due to the pension funds now being included in the estate, and they would likely lose the RNRB as the total estate value exceeds the £2 million threshold.
Impact on Family Businesses
These changes will be even more pronounced for families who own trading businesses or other qualifying assets. For example, consider a couple who own a trading business valued at £10 million. Under current rules, their IHT liability might be around £340,000, assuming the business qualifies for full BPR.
However, after April 6, 2027, their IHT liability would balloon to £2.34 million, with substantial portions of the estate being taxed at 40%. For instance, £1.6 million of the liability could arise from the business despite qualifying for BPR due to changes to APR and BPR rules. The business would likely need to generate additional income to fund the IHT payment, which could significantly strain the company’s finances.
Strategic Planning for Succession
The key takeaway is that the changes to IHT rules are more extensive than they may initially appear and could have a major impact on the succession plans of many families. The concept of the pension pot being a last resort is likely to change as pensions are now likely to be one of the first funds subject to IHT. Families relying on BPR for their businesses must consider the £1 million cap on relief and think carefully about potential lifetime gifting strategies.
Given these far-reaching changes, families should begin rethinking their succession plans now, even though the new rules won’t take effect immediately. Reworking these plans takes time, so it’s important to get expert advice and act sooner rather than later to mitigate the impact of these upcoming changes.
With recent changes to inheritance tax regulations, now is the ideal time to review your succession plan.
At Wills Tax & Trust Ltd., our Managing Director, Ray Best, has extensive expertise to help you develop tailored strategies that reduce your IHT liability, protect your family assets, and ensure a smooth transition to the next generation.
Contact us today to arrange a consultation and take the next step in securing your family’s future.
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Ray Best
Like his academic development, writing came late to Ray. He has written several published works, “Inheritance Tax Planning – My Way” and “Shareholder Protection & Partnership Protection” and has had four feature articles published in Tax Adviser magazine, but the publication he is most noted for is the joint collaboration with Tony Granger “Inheritance Tax Simplified”.
