Investment - Articles - How to navigate changing IHT rules with good estate planning

 In the October Budget, Chancellor Rachel Reeves announced that defined contribution pension pots will be included in estates’ inheritance tax liabilities from April 2027, and she also froze the nil rate bands for an extra two years, until April 2030.

 The Chancellor additionally reduced business and agricultural property relief from April 2026. The first £1mn of combined business and agricultural assets can still be passed on tax-free, but IHT will be levied at 20 per cent on the rest. A 20 per cent rate will also apply to AIM shares.

 Ian Dyall, Head of Estate Planning at wealth management firm Evelyn Partners, says: 'Estate planning is about a lot more than just inheritance tax: it’s a peace-of-mind strategy to help families pass on wealth in the best way, one that meets as many of their needs and objectives as possible.

 ‘But it is true that more families will be drawn into the web of inheritance tax in the coming years, and some of those will need to start planning now if they want to mitigate the effects. 

 ‘The IHT rule changes could really undermine many families’ current plans for transfer of wealth, leaving them exposed to quite significant tax bills. So as we head into 2025, there’s an important opportunity for many households to look at their estate planning, not just through a tax lens but also thinking about what they want to do with their assets and what will end up being best for the family’s future.’

 Make or check your Will(s)

 Ian says: ‘If you don’t have a Will then making one is often a huge step in establishing financial security and peace of mind for your family – especially if you can get your solicitor to work closely with a good financial planner. This can prevent unnecessary stress and even disputes for the administrators and beneficiaries of an estate and could save them having to pay unnecessary inheritance bills.

 ‘Having Wills in place is especially crucial for unmarried couples in long-term relationships - as the intestacy rules could lead to an unwelcome distribution of assets at death - and for blended families where uncertainty and misunderstanding can arise. Where the family home is not jointly owned, that could also create issues at death and couples can consider how their property is owned at the same time as looking at Wills.

 ‘Even where Wills are in place, and especially if they were made some time ago, make sure that they still do what you want them to, and that new tax rules do not require a rethink.

 ‘To take one example, after the changes to business relief and agricultural property relief in the Budget, for many families with businesses or farms the traditional mirror Wills for married couples – where the couple leaves everything to one another and then to their children - might no longer be the best option to maximise the use of available IHT reliefs.

 ‘The £1m business relief 100% band is not transferrable to the surviving spouse, so leaving everything to your spouse could waste the allowance of the first spouse to die. Leaving BR assets up to the £1m band either directly to children, or to a trust that the surviving spouse can benefit from on first death may result in a significant inheritance tax reduction.

 'It’s also a good time to reflect on articulating your wishes at a time of lost capacity and possibly arrange lasting power of attorney. You can register an LPA at any time and nominate one or more trusted persons, but you do not have to grant it until the need arises.’

 Gift or spend

 Ian says: ‘More estates will find they are likely to incur growing IHT liabilities, whether that is the result of the inclusion of pensions as a taxable asset, or the dilution of reliefs, or just because growth in asset values is dragging them over the nil-rate bands. Their residence nil-rate band could also start to disappear if their estate starts to be valued at more than £2million.

 ‘One perennial remedy for this is to spend more on yourself and your family or to give away more wealth during lifetime to shrink the estate so that less of it is taxable at death. Many older savers and investors find it difficult to switch from accumulating wealth to spending it or giving it away, so sometimes this can require a bit of a change of outlook.

 ‘Then the big question is usually, are you happy to lose control of the funds that you’re giving away? Both in the sense of whether it leaves you with sufficient funds to live out the rest of your life the way you want to, which is where a financial planner’s forecasts can come in very useful. And also of whether you’re happy that your relatives will use your generous gifts in a way that you’d prefer.

 ‘Trusts put in place with expert advice can be invaluable because this is a way to retain some control over assets while still gifting them and setting the “seven-year clock” ticking. Families must also pay heed to the gifting rules which are not straightforward.

 ‘It’s important not to make drastic decisions off the back of the Budget announcements. Now is probably the time to think about a longer-term gifting plan rather than making ad hoc handouts, ideally with the assistance of professional advice.’

 Get married?

 Ian says: ‘Wealth left to a spouse or civil partner is exempt from IHT, and that will apply to pension pots too. So for many people this might only become an IHT “problem” when they are the surviving spouse.

 ‘However, for those who are in a relationship but unmarried – whether co-habiting or not – the issue becomes more pressing. It could well be that many older couples in long-term relationships decide to tie the knot to make this problem go away, for a certain timespan at least.

 ‘Anyone who is married should check their pension death benefit nomination, as after this rule change it will be best for most couples’ IHT purposes to stipulate that the pension is paid in total to your spouse when you die, rather than any portion left to children or other family members.’

 Couples: review how assets are owned and distributed

 Ian says: ‘The changes in the Budget mean that both husband and wife need to ensure that they use their allowances, particularly if they own business or agricultural assets, but even if they have a large pension which will be liable to IHT in a couple of years’ time.

 ‘They need to try to keep the surviving spouse’s estate below £2million on second death to preserve the residential nil-rate band, which may mean gifting assets up to the nil-rate band on the first death.

 ‘It might also mean trying to avoid bringing other assets into the estate like their own inheritances from parents. It can be tax-efficient to skip a generation and pass these straight on to grandchildren using a deed of variation.

 ‘Similarly, married entrepreneurs must look at how they own their business. A successful married entrepreneur who has a business held solely in their name could be looking at a substantial IHT bill under the new rules as they will only have one lot of £1million APR/BPR. That might mean the business has to be sold in the event of their death to fund the tax bill.

 ‘So they might seek to mitigate their future IHT liability by moving the business to shared ownership with their spouse. Their Wills might also need to be revised to make a gift on first death either to children or to trust rather than to the spouse.’

 A pensions rethink

 Ian says: ‘The Budget rule change means retirees might not necessarily want to be sitting on a big pension pot when they die, as it will add to the value of the estate and could either create or add to an IHT liability.

 ‘Moreover, under current rules, the pension IHT change could mean that some pots are “double-taxed” if the holder dies at age 75 or older, because then the beneficiary could also be charged income tax at their marginal rate as they withdraw funds from the pension that has already been subject to IHT at 40%.

 ‘If the beneficiary is an additional rate 45% taxpayer then they will get just 33p in the pound from the passed-on pension - an effective tax rate of 67%. Also, if the addition of pension savings will push the total value of an estate over the £2million mark, then the residence nil rate band will start to disappear and IHT bills will become even more onerous.

 ‘So around the age of 75 a retiree could start to draw down more rapidly on their pension pot, rather than use other assets as they might have done under current IHT rules. But the possible IHT saving must be set against the tax paid on the pension withdrawals – especially where the saver is close to a big marginal tax step or paying the 45% additional rate. We might see some savers accelerate the withdrawal of their 25% tax-free lump sum, either to spend or even gift it to set the seven-year clock ticking.

 ‘Another tactic would be to take regular withdrawals from the pot as income, in order to make gifts using the “normal expenditure from income” rule. Such regular gifts could be free of IHT, as long as they meet the rules, which can be finicky, so this is a process best managed with advice. 

 However, Ian warns: ‘If you are trying to use the excess income exemption, what you can’t do is take all your tax-free cash, stick it in a bank account and gift it gradually from there, as then it will be seen as a gift from capital and not from income.’

 Insure your IHT liability

 Ian says, ‘For those who are looking at substantial IHT liabilities after pensions are included in estates, taking out whole of life cover can be an efficient way of insuring your inheritance tax liability, so beneficiaries do not have to pay it themselves.

 ‘You can take out a life insurance policy for all or part of the estimated IHT bill and crucially, have it written into trust so the eventual payout does not form part of your estate for tax purposes. You pay the monthly premiums and when you die the trustees (your beneficiaries) can use the proceeds to promptly settle the IHT bill.

 ‘If you are married or in a civil partnership, then the best option is a “joint life, second death” policy. This means that both of your lives are insured but the policy will only pay out to your beneficiaries on the second death. The first death does not need to be insured as the surviving spouse inherits assets tax-free.

 ‘This can also have the added benefit of saving executors some potential stress as it will provide accessible funds to settle the IHT liability with HMRC, which must be done before probate is granted.

 ‘Those wishing to draw down more heavily on their pension pots in light of the impending IHT rule change could use withdrawals to fund such a policy, as they can be expensive.’