A brief background to IHT and the available allowances
Inheritance tax (IHT) is the tax imposed on the estate of someone who has passed away, which includes assets such as your home and savings.
Everyone benefits from a £325k ‘nil-rate band (NRB)’ and an additional ‘residential nil-rate band (RNRB)’ of £175k when a residential property is left to direct descendants.
Spouses can leave assets to each other free from IHT, as well as transfer any unused nil-rate bands to the survivor.
This means that married couples can leave up to £1m to their children without needing to consider ways of mitigating potential IHT.
These allowances have been frozen until 2028, bringing IHT conversations further into focus for many. The announcement of pension legislation changes in the last Autumn Budget has only heightened these concerns, prompting more people to consider the most effective ways to pass wealth on to their loved ones.
What has historically been the rules with pensions?
As well as helping to provide an income in later life, a lesser-known benefit of pensions has been their role in passing unspent savings to loved ones. Currently, regardless of value, they are not included in your estate and can therefore be passed on free of IHT.
This is in contrast to other assets, such as your home and savings, which are subject to IHT at 40% if the total value exceeds the available allowances.
What is changing?
From April 2027, the government have proposed that pensions will be brought into an individual’s estate, and will potentially be subject to IHT at 40%, dependent on if the value exceeds the available nil rate bands.
What can be done to mitigate this?
While awaiting the final details, we would advise caution before making drastic changes to pension savings. However, adjusting pension beneficiaries in the short term may be useful, as this can be revised at any time. Our logic behind this:
- At present, most spouses nominate each other as the beneficiaries so that the savings can be used to fund the survivor’s living expenses
- However, if both partners have sufficient non-pension savings to cover their long-term expenditure, and pension savings are unlikely to be needed for personal spending, there may be benefit in exploring alternative strategies
- For example, having non-spousal nominations before April 2027 would allow pension savings to be passed on free from IHT if either couple dies under the current rules
What about after April 2027?
When the changes go ahead, there are still important tax exemptions that will apply – such as the spousal exemption. This exemption allows assets to pass between married couples or civil partners, free of IHT, regardless of value.
So, from April 2027, nominating your spouse as your beneficiary could still be an effective way to mitigate any potential IHT on first death. The pensions would then form part of the couple’s estate upon second death, however, this approach allows for flexibility in the meantime.
Looking ahead
With change on the horizon, it is important to review your pension nominations and understand how they align with your estate planning.
As always, we are here to help. So please don’t hesitate to get in touch if you would like to talk anything through.