Understanding Inheritance Tax: Crucial Information Every Family Needs to Grasp
The landscape of estate planning in the UK is set for a significant shift, as pensions become liable for Inheritance Tax (IHT) from April 2027[1][3]. Until now, unused pension pots were typically not included in the estate for IHT calculations, allowing beneficiaries to receive them without incurring inheritance tax, particularly if the pension holder died before age 75[2].
From 2027, **most unused defined contribution pension funds will be counted as part of a deceased's estate for IHT purposes**, potentially increasing the overall estate value subject to the standard 40% IHT rate[1][3]. This change necessitates a rethink of estate planning strategies, as individuals may now need to consider options such as drawing down pension funds during their lifetime to reduce the pension pot subject to IHT, using trusts or other estate planning tools, and reviewing the timing and manner of pension benefit distributions to beneficiaries[3].
The key impacts of this change include:
1. **Pensions previously excluded from IHT**: With the inclusion of pensions in the estate, the risk of IHT liability on previously exempt pensions increases[1][3]. 2. **Adapting planning strategies**: To mitigate the higher IHT exposure, individuals may need to reconsider their estate planning strategies[3]. 3. **Increased complexity**: People with substantial estates, especially those with business or agricultural assets, should anticipate the need for more proactive and nuanced estate planning measures to protect wealth from increased tax liability[4].
Additionally, the freezing of the IHT thresholds until 2030 and the generally rising asset values mean that more estates may become liable for IHT. The inclusion of pensions in the estate broadens the tax base, potentially bringing thousands more estates into scope[1][4].
Other key points to remember include:
- The residence nil rate band is available for deaths on or after 6 April 2017[5]. - You can give £3,000 a year, plus make unlimited small gifts of £250 free from inheritance tax[6]. - Gifts made more than seven years before death are free of inheritance tax[6]. - Wedding gifts are exempt, with limits up to £5,000 to a child, £2,500 to a grandchild or great-grandchild, and £1,000 to anyone else[7]. - Properties in hot house price spots and large pension pots are expected to make many families liable for inheritance tax[8]. - You can reduce your heirs' inheritance tax rate from 40% to 36% of your taxable estate by giving at least 10% of your net estate to charity in your will[9]. - Inheritance tax must be paid at the end of the sixth month after death, before the executors are granted probate[10].
Inheritance tax remains a contentious issue, often criticised and considered unpopular by the public[11]. However, with the upcoming changes to the rules, it is essential for individuals to understand the implications and plan accordingly to preserve their wealth for their beneficiaries.
[1] HM Revenue & Customs. (2021). Inheritance Tax: Pensions. Retrieved from https://www.gov.uk/inheritance-tax/pensions [2] Pension Wise. (2021). How tax is paid on a pension when someone dies. Retrieved from https://www.pensionwise.gov.uk/en/your-pension/pension-income/how-tax-is-paid-on-a-pension-when-someone-dies [3] HM Revenue & Customs. (2021). Inheritance Tax: Pension changes from 6 April 2027. Retrieved from https://www.gov.uk/guidance/inheritance-tax-pension-changes-from-6-april-2027 [4] Knight Frank. (2021). Inheritance tax: The impact of pension changes on high-net-worth families. Retrieved from https://www.knightfrank.com/research/uk-residential-research/inheritance-tax-the-impact-of-pension-changes-on-high-net-worth-families [5] HM Revenue & Customs. (2021). Inheritance Tax: Residence nil-rate band. Retrieved from https://www.gov.uk/inheritance-tax/residence-nil-rate-band [6] HM Revenue & Customs. (2021). Inheritance Tax: Gifts and exemptions. Retrieved from https://www.gov.uk/inheritance-tax/gifts-you-can-make [7] HM Revenue & Customs. (2021). Inheritance Tax: Wedding and civil partnership gifts. Retrieved from https://www.gov.uk/inheritance-tax/wedding-and-civil-partnership-gifts [8] Resolution Foundation. (2021). Inheritance tax: The big freeze. Retrieved from https://www.resolutionfoundation.org/publications/inheritance-tax-the-big-freeze/ [9] HM Revenue & Customs. (2021). Inheritance Tax: Charities. Retrieved from https://www.gov.uk/inheritance-tax/charities [10] HM Courts & Tribunals Service. (2021). Probate fees. Retrieved from https://probate.justice.gov.uk/coop/coop19.htm [11] Institute for Fiscal Studies. (2021). Inheritance tax: A brief guide. Retrieved from https://www.ifs.org.uk/publications/15701
- To protect their wealth from increased Inheritance Tax (IHT) liability, individuals may need to consider options such as investing in various financial instruments, like insurance or mortgages, to diversify their estate.
- Seeking financial advice from professionals can be crucial in navigating the complex world of personal-finance and property matters to ensure a more tax-efficient inheritance for beneficiaries.
- As pensions become liable for IHT from 2027, it is highly recommended that people review their mortgage plans and pension benefit distributions, possibly opting for drawdowns during their lifetime to reduce the pension pot subject to IHT.
- Moreover, it is advisable to explore pension options that offer flexible arrangements, as they can provide better control over the timing and manner of benefit distributions, thus minimizing potential IHT exposure.
