The Autumn Budget updated inheritance tax (IHT), affecting how much of your estate you can pass on tax-free.
Although less severe than expected, more people will likely pay IHT in the coming years. So, it’s important that you review your plans and minimise the potential tax burden.
What’s Changed?
Chancellor Rachel Reeves introduced three key changes to IHT that could impact many estates:
- Freezing the Tax-Free Threshold: You can pass on £325,000 without paying IHT per person or £500,000 if you leave your home to children or grandchildren. This amount has been the same since 2009 and will remain unchanged until 2030. Because inflation reduces its value, more estates are likely to exceed the tax-free limit.
- Pensions Now Subject to IHT: Beginning in April 2027, pensions will be considered part of your estate and subject to IHT. In the past, pensions were beneficial for estate planning because they could be transferred tax-free. Now that this benefit is lost, many people need to reassess their plans.
- Reduced Reliefs on Business and Agricultural Assets: Starting in April 2026, agricultural and business property tax relief will be limited to £1 million. Any amount over this will be taxed at 20%. A similar tax rate will also apply to Aim shares, previously wholly exempt after two years.
The outcome? IHT is expected to generate nearly £14 billion a year for the government by 2030, almost twice what it earned last year. The share of estates paying IHT is projected to increase from 5% to nearly 10% in the next six years.
If your estate’s value, like your home, savings, pensions, and other assets, is near or above the tax-free limit, you might leave a bigger tax bill for your family. The good news is that there are still ways to lessen the impact of inheritance tax, but you’ll need to plan ahead.
Strategies to Reduce Inheritance Tax
Planning for IHT means balancing your lifestyle with minimising the tax on your estate. Here are some simple strategies to consider.
Giving Assets While You’re Alive
Gifts you make while alive are free from IHT if you live at least seven years after giving them. If you live for four to six years, the tax reduces gradually and becomes zero after seven years. As pensions will be subject to IHT starting in 2027, you may want to consider withdrawing money to gift while you are alive. You might want to withdraw your 25% tax-free lump sum to give to your beneficiaries. You can also take out extra from your pension to gift, as long as it doesn’t affect your everyday living. Regular gifts like this can be exempt under the “normal expenditure from income” rule. If you’re a basic-rate taxpayer (20%), gifting from your pension might be beneficial since the IHT rate is 40%. However, the advantages are less clear-cut if you pay a higher tax rate (40%).
Using Trusts
Trusts are a common way to give assets while keeping some control. For instance, you can decide how and when your beneficiaries can use the money. While trusts may not always be the best option for reducing taxes, they can provide reassurance in certain situations.
Investing in Aim Shares
Shares on the Alternative Investment Market (AIM) are eligible for inheritance tax relief after two years, but this relief has dropped from 40% to 20%. AIM shares are considered high-risk, making them more suitable for investors who can commit for a longer period. Some individuals may look to AIM shares as a quick fix for IHT issues, but this can be risky if they are not prepared for potential fluctuations.
Setting Up Life Insurance
A life insurance policy written into a trust can provide your beneficiaries with the funds they’ll need to pay the IHT bill. This is especially useful if your estate includes illiquid assets like property, which may be difficult to sell quickly. By having the policy in a trust, the payout avoids IHT and can be accessed immediately after your death.
What should I watch out for?
While these strategies can help lower your IHT bill, it’s essential to plan ahead:
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Illiquid Assets: If your estate includes property or items that are hard to sell, your heirs may struggle to pay inheritance tax (IHT). Life insurance can help cover this expense.
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Pensions After 2027: When pensions are part of your estate, your beneficiaries might have to pay income tax and IHT on the money they withdraw. This highlights the importance of early gifting or careful planning.
Why Planning Matters
The new inheritance tax rules make it crucial to plan ahead. A solid plan can help save your family a lot of money in taxes. Since everyone’s situation is unique, it’s wise to talk to a financial adviser who can create a plan that fits your needs. Planning now allows you to enjoy your wealth while maximising what you leave for your family.
