The two-year window: How to prepare for upcoming Inheritance Tax changes

Advertisement: This is sponsored content provided by Kellands Hale

In the lengthy 2024 Autumn Budget, one of the Chancellor’s main announcements was that the Government plans to subject unused pension benefits to Inheritance Tax (IHT) from April 2027.

With two years to go before this legislation is set to come into force, let’s break down what it will actually mean for your estate, plus some ways you might be able to prepare.

Until April 2027, you can pass down unused pension benefits free of Inheritance Tax

You might already be looking at your estate and thinking about ways to mitigate IHT.

One way to do this, at the time of writing, is to leave a portion of your wealth in your pension and pass it down to the next generation when you die. Pension wealth falls outside of your estate for IHT purposes, meaning you could leave a sizeable chunk to your beneficiaries while knowing it will escape the IHT net.

Outside of your pensions, there are also the nil-rate bands, which protect a certain portion of your taxable assets from IHT:

• The nil-rate band lets you pass on assets and cash worth up to £325,000 IHT-free.
• The residence nil-rate band offers an additional £175,000 of relief to those passing down their main home to direct lineal descendants.

So, as an individual, you can currently pass on up to £500,000 before any IHT is due. What’s more, you can inherit your spouse or civil partner’s unused nil-rate bands.

Between you, there’s currently the opportunity to pass £1 million on to the next generation IHT-free, plus any unused pension benefits.

The Chancellor has proposed that pensions be caught in the Inheritance Tax net from April 2027

While the nil-rate bands are frozen until 2030, the Chancellor has proposed that pensions should be included when a person’s estate is valued upon death, meaning funds left within a pension could be liable for IHT from April 2027.

While this legislation is not currently set in stone, if it comes into place as planned, your family’s IHT liability could rise very substantially.

How to prepare for the potential taxation of your pension upon death

While it is yet unclear how this legislation will be enforced in practice, it may be worth taking the opportunity to review your estate plan in the next two years. As pension savers have been given the gift of time in this area, it may be a good idea to review your plan and make the necessary alterations now.

While we believe this is best done after taking advice from an independent financial planner, some strategies you could explore are:

Making lifetime gifts

Gifting money to your beneficiaries over the course of your life can reduce the value of your estate gradually, leaving less in the hands of HMRC when you pass away. Some gifts could still be subject to IHT if you make them within seven years before you pass away.

Making “gifts from surplus income” once you start drawing your pension

If you have very substantial pension wealth and know you will be comfortable for the rest of your life, you could consider gifting away some of the funds you draw from your pension. This could be classed as “gifting from surplus income” and therefore be entirely IHT-free. It would be wise to consult a financial planner before doing so, to ensure your plans are affordable and sustainable.

Living life to the fullest once you retire

While you may have previously been planning to leave pension wealth behind in order to fund opportunities for the next generation, this latest legislative shift might prompt you to spend your funds and enjoy life to the fullest. Once again, it’s important to take long-term advice, to ensure you are not overspending in your early retirement years.

Putting whole of life cover in a trust

Whole of life insurance means that the cover won’t lapse when you reach a certain age, and placing this in trust can ensure it remains outside of your estate for IHT purposes. If your beneficiaries receive a payout, they may then be able to use this money to pay an IHT bill.

Ringfence other assets into a trust

Although trusts are not always “IHT-free”, they typically allow you to pay IHT at a reduced rate and come with several other benefits too. That said, it’s crucial to speak to a financial planner about the potential drawbacks of trusts, including fees, before you place assets into one.

Your unique circumstances require careful and personal attention, so some or all of these suggestions might not be quite right for you. Nevertheless, now is the time to begin looking at the potential levy of IHT on your pensions, and to discuss this with a professional who can provide you with long-term solutions.