Last October, when Chancellor Rachel Reeves announced new rules relating to inheritance tax (IHT) and pensions, some people assumed the change would mainly impact affluent retired people or those approaching retirement.
Doran Mitchell, Director in our Private Client team, explains that what they may not realise is that the changes could also create IHT traps for younger families and couples, in ways that could stretch their finances after the death of a partner or spouse.
The changes explained
Until now, most unspent pension funds have not been subject to IHT when someone dies, but the Budget proposed to change that from April 2027. As a result, some families and couples could unexpectedly find their estate subject to IHT on death. In addition, the change could delay Death in Service payments.
Many couples assume their assets won’t be subject to IHT because they do not have huge savings or investments. However, they forget the possible effects of house price rises and the freezing of the IHT threshold (see In brief section below).
For example, a property with a market value of £250,000 in 2025 could perhaps be worth £300,000 or more in 2030. Add to that other assets like a workplace or personal pension or Death-in-Service payments, and people could find themselves above the £325,000 IHT threshold in a few years’ time if no other allowances or reliefs are available.
This is especially significant for unmarried partners who co-own property because they won’t benefit from the IHT exemption for spouses. Having to pay IHT at 40% on anything over the available threshold could strain their future finances and leave them in a difficult position.
Payment delays
There’s also a second change that could hit families or couples. Under the Budget proposals, pension scheme administrators would become liable for reporting and paying to HMRC any IHT due on pension funds and death benefits.
Currently, death in service payments can be made relatively quickly, but from 2027 pension providers would likely need to wait until the deceased’s executors had finalised other estate and IHT arrangements. If the deceased’s family are relying on a payout to cover funeral, mortgage or other expenses, the delay could create financial hardship.
Your options now
The 2024 Budget proposals on IHT are yet to be converted into legislation, so the details may change. Even so, they’re a further incentive for individuals and families to consider how to ease the financial and legal arrangements for their families through making a Will and doing some IHT planning.
The pension changes in the Budget are not a reason for people of any age to reject saving into a pension, but they are a useful reminder of the benefits of planning ahead and taking advice, whatever your age.
In brief
Inheritance tax is a 40% tax on the value of someone’s net assets (including their possessions, savings, investments and property) when they die. There are various exemptions and reliefs available, for example:
- No tax is payable on the value of assets below £325,000 (known as the nil-rate band).
- If you leave your home to children or grandchildren, there is an additional nil rate band of up to £175,000 available in certain circumstances.
- No tax is payable on assets left to a spouse or civil partner.
- Any unused nil-rate band can be added to the surviving spouse’s nil-rate band.
The nil-rate band of £325,000 has been frozen since 2009 and the Budget changes mean it won’t change until at least 2030. In the meantime the value of assets like property could continue to increase, meaning that many more families will be drawn into the IHT net. The inclusion of pensions and death in service payments in IHT calculations will surely add to this number.
