2024 BUDGET UPDATE
A Case Study on Inheritance Tax Mitigation Post Budget
In Labour's first Budget for 14 years, the Chancellor announced £40 billion of tax raises. One of the main areas targeted was Inheritance tax, and changes to the treatment of certain assets will bring estate planning into sharper focus for many of our clients. One of our Financial Planners, Tom Humber, presents a case study outlining the potential impact.
The recent Budget announced several upcoming changes to the Inheritance Tax treatment of certain assets which will bring estate planning into sharper focus for many of our clients.
What are the changes that have been announced?
From 6 April 2027 any unused pension funds will form part of your estate for Inheritance Tax calculations, which may result in your pension fund being taxed by up to 40%.
From 6 April 2026 certain assets which currently attract 100% Inheritance Tax relief, such as certain unquoted or AIM listed shares, Agricultural property and many other privately owned businesses, will see their relief reduced.
Under the proposed new rules, only the first £1 million of these specific business and agricultural assets will have 100% Inheritance Tax relief apply, with any excess only eligible for 50% relief, resulting in an effective Inheritance Tax charge of 20%. It is important to note that the £1 million allowance is per person but that any unused allowance cannot be passed on to a spouse or civil partner.
It should be remembered that the majority of exemptions and gifting allowances which can reduce Inheritance Tax are still available and have not been curtailed by this latest Budget. For example, any assets passed to a spouse or civil partner will not be subject to Inheritance Tax, and the Nil Rate Band of £325,000 per person remains in place, with the potential for a further £175,000 per person via the Residence Nil Rate Band. Rules surrounding lifetime gifts remain unchanged and are likely to become much more relevant now that the other options for pensions, business relief and agricultural relief have been reduced.
What approach should be taken?
When it comes to your personal financial planning, the most important factor to consider is whether you have sufficient assets to meet all of your needs during your lifetime. If that is not the case, then Inheritance Tax planning should be a secondary concern to you, with the focus instead being on saving and then drawing from your assets in a sustainable manner.
If you have enough assets and income sources to realistically provide for your lifetime, you should then consider whether there is likely to be an Inheritance Tax liability, and if so, the extent of it. There are still a number of allowances and exemptions available which could reduce, or eliminate entirely, the potential tax liability, so it is important to receive personalised advice or guidance relevant to your circumstances, before making any decisions.
If there is a likely to be an Inheritance Tax liability on your estate, and it is a priority for you to reduce it, there are options available to you, each with different levels of risk and consideration:
Lifetime Gifting
If affordable, you could make gifts during your lifetime to your intended beneficiaries, or into Trust, as a means of reducing your estate.
There are a number of gifting allowances you can use each year, such as the £3,000 annual gift exemption, as well as the ability to make gifts out of excess income, which will have the effect of reducing the accumulation of assets within your estate.
Especially large gifts can also be made, known as Potentially Exempt Transfers (PETs), where you must survive for seven years for the value to be fully outside of your estate for tax purposes.
Life Insurance
If you do not feel that you are in a position to gift your assets away, but still have a concern about Inheritance Tax, you could consider setting up a life insurance policy.
This would provide funds to your intended beneficiaries upon your death, with the purpose of paying for some, or all, of the expected Inheritance Tax liability. This would allow you to continue to control your assets throughout your lifetime, and the regular premiums for the policy would have the effect of reducing the value of your estate.
The options above are not mutually exclusive and the solution may be a combination of those which work for you. What is important however is seeking advice before making any major estate planning decisions.
Estate Planning and the Residence Nil Rate Band
The Residence Nil Rate Band is an Inheritance Tax-free allowance of up to £175,000 per person, which applies where a home is being inherited by a direct descendant. When combined with the standard Nil Rate Band of £325,000 per person, up to £1 million can pass from a married couple to their beneficiaries without tax applying.
However, the Resident Nil Rate Band is tapered by £1 for every £2 the estate exceeds £2 million, and with the value of pensions due to be included for Inheritance Tax purposes by 6 April 2027, many more estates are likely to exceed this threshold. The impact of this can be mitigated however by leaving a portion of the estate to beneficiaries on first death, rather than everything being inherited by the surviving spouse.
In the first example, a couple have an estate of £2.8 million, including a home valued at £1 million. On first death, all of the assets pass to the remaining spouse, who also then inherits the deceased’s nil rate band. On the assumption of no other reliefs applying, the Inheritance Tax for their beneficiaries, on second death, would then be calculated as follows:
| Total Estate | £2,800,000 |
|---|---|
| Nil Rate Bands (x2) | £650,000 |
| Residence Nil Rate Band (Fully Tapered) | £0 |
| Taxable Estate | £2,150,000 |
| Tax at 40% | £860,000 |
| Net Estate | £1,940,000 |
If, however, on the first death £800,000 had been left to the beneficiaries, the amount of tax payable would reduce, as follows:
| First Death | £800,000 |
|---|---|
| Nil Rate Band | £325,000 |
| Residence Nil Rate Band | £0 |
| Taxable Estate | £475,000 |
| Tax at 40% | £190,000 |
| Net Estate | £610,000 |
As you can see there would be an IHT liability due in excess of the £325,000 nil rate band which applies on first death.
The nil rate band would not be inherited by the spouse, however as the remaining estate has reduced to £2 million, they would no longer have a tapered residence nil rate band apply:
| Second Death | £2,000,000 |
|---|---|
| Nil Rate Band | £325,000 |
| Residence Nil Rate Band | £175,000 |
| Taxable Estate | £1,500,000 |
| Tax at 40% | £600,000 |
| Net Estate | £1,400,000 |
The total net estate inherited by the beneficiaries would be £2,010,000 compared to the £1,940,000 in the first scenario, thereby saving the beneficiaries £70,000 in tax.
However, it is essential to ensuring that the surviving spouse retains enough assets to meet their needs for their lifetime before passing on wealth to beneficiaries on first death, especially in cases where a property makes up a large portion of the estate.
Estate Planning for Business and Agricultural Relief
The proposed changes may also mean that married couples whose wealth derives from business assets or agricultural assets may also wish to alter their wills to provide more to their beneficiaries on first death, rather than passing everything to their spouse. This could provide the estate with a potential Inheritance Tax saving of up to £200,000.
To demonstrate, let’s consider a married couple who have a combined estate of £5,000,000, in which £2,000,000 is held in qualifying business assets. The inheritance tax calculation if the entire estate went to the surviving spouse would look like this:
| Non-Business Assets | £3,000,000 |
|---|---|
| Business Assets | £2,000,000 |
| Total Value of Estate | £5,000,000 |
| Nil Rate Bands (x2) | £650,000 |
| Business Asset Allowance | £1,000,000 |
| Taxable Estate | £3,350,000 |
| Tax at 40% | £1,340,000 |
| Business Relief at 50% on £1,000,000 excess | £200,000 |
| Total tax due | £1,140,000 |
| Net Estate | £3,860,000 |
If instead, £1,000,000 was provided to the beneficiaries on first death from the business assets, with the remaining estate passed to the spouse, then this would be provided without any Inheritance Tax applying as it would fall inside of the £1 million allowance. On second death, the calculation would then be as follows:
| Non-Business Assets | £3,000,000 |
|---|---|
| Business Assets | £1,000,000 |
| Value of Estate | £4,000,000 |
| Nil Rate Bands (x2) | £650,000 |
| Business Asset Allowance | £1,000,000 |
| Taxable Estate | £2,350,000 |
| Tax at 40% | £940,000 |
| Business Relief at 50% on £1,000,000 excess | £0 |
| Total tax due | £940,000 |
| Net Estate | £3,060,000 |
| Plus Inheritance at First Death | £4,060,000 |
This saving occurs because any unused £1 million Business and Agricultural allowance is not able to be inherited by a spouse, which is different to the rules surrounding the Nil Rate Band.
Risk Warnings and Next Steps
It is important to note that the changes outlined by the Budget are proposals which are under consultation, and yet to be set out in law so they may change. Furthermore, as many of the changes are not due to come into effect until 2026 or 2027, there is no urgency to make any immediate decisions. Instead, we would recommend that you speak to your financial planner to discuss how these changes may affect you, and what steps could be taken which suit your circumstances.