In the recent UK budget, the Chancellor, Rachel Reeves announced a range of changes in the way estates are dealt with for Inheritance Tax (IHT). These changes will have significant implications for many people, especially homeowners with property prices reaching record levels in recent times, potentially pushing their estates above the inheritance tax threshold. That is why it is more important than ever to consider estate and Inheritance Tax planning
As the size of your estate grows, there is a greater chance of it passing through the threshold above which IHT will be payable.
Understanding Inheritance Tax
Inheritance tax is a levy on the estate of someone who has passed away. The executor or administrator of the estate typically has to calculate and deal with Inheritance Tax. The IHT threshold, also known as the nil-rate band, is currently set at £325,000. Estates valued above this threshold are subject to a 40% tax rate on the amount exceeding the threshold.
Recent changes have introduced the residence nil-rate band, which provides an additional £175,000 tax-free allowance when a primary residence is passed on to direct descendants, such as children or grandchildren. This means that with careful inheritance tax planning, it is possible to significantly reduce the amount of IHT payable on an estate.
The nil-rate and residence nil-rate bands
The current IHT regime has a range of allowances available to estates, at the core of which are the nil-rate and residence nil-rate bands.
The nil-rate band is the amount your estate must reach before you have to pay Inheritance Tax. This currently stands at £325,000. That means if your estate is over that amount, it may be liable to IHT.
The nil-rate band has been frozen at this level for a number of years and the freeze was due to continue until April 2028. However, the Chancellor has extended the freeze and it will now continue until April 2030.
Clearly this means as property prices continue to grow and the assets and investments people own increase, estate and inheritance tax planning become essential.
In addition to the nil-rate band, there is also the residence nil-rate band. This is a further allowance of £175,000 available when you leave your family home or your interest in the family home to a child or grandchild.
The nil-rate and residence nil-rate bands are transferable
If you are married or in a civil partnership, on first death, any unused portion of the nil-rate and residence nil-rate band can pass to the surviving spouse or civil partner. That means, in essence, there is a potential combined nil-rate allowances of up to £1 million available for a surviving spouse or civil partner before IHT is payable.
There are, however, important things to note, the first of which is that there is no IHT payable for transfers between spouses or civil partners. That means if one spouse or civil partner leaves their entire estate to their surviving spouse or civil partner, there are no IHT implications at that time. However, this might simply be stoking up a problem for the future when the surviving spouse or civil partner dies, potentially resulting in a large inheritance tax bill.
Also, if you are cohabiting and not married or in a civil partnership, the nil-rate and residence nil-rate band do not transfer to your partner.
Also, if your net estate is valued at more than £2 million, the residence nil-rate band reduced by £1 for every £2 of estate over the £2 million figure.
Using your nil-rate band allowances are an important aspect of estate and Inheritance Tax planning. Also, the sooner you start planning, the better.
Calculating Inheritance Tax Liability
Calculating inheritance tax liability involves determining the total net value of the estate, which includes all assets such as property, savings, investments, and personal effects less any debts of the deceased. The tax rate of 40% applies to the portion of the estate that exceeds the nil-rate band of £325,000.
However, there are several reliefs and exemptions available that can help reduce the IHT bill. For instance, as previously mentioned, the residence nil-rate band offers an additional £175,000 tax-free allowance when passing on the family home to direct descendants. Charitable donations can also reduce the taxable amount of the estate.
Engaging a solicitor can be invaluable in navigating the complexities of IHT and ensuring that the tax burden is minimised. They can provide estate planning advice and help you take advantage of all available reliefs and exemptions, making it easier to mitigate against inheritance tax where possible.
IHT to be applied to unused pensions
Pensions have been a key tool for many in estate and Inheritance Tax planning as the value of an unused pension fund falls outside the value of the estate. These are similar to potentially exempt transfers (PETs), where the value of an unused pension fund falls outside the value of the estate.
However, the Chancellor has decided that from April 2027 any unused pension fund will be subject to IHT with the pension trustees and administrators being responsible to paying the IHT to the Treasury. How this is going to work in practice is subject to a consultation which was launched on Budget day.
Of course, if you nominate your spouse or civil partner to receive your unused pension on your death, no IHT is payable. That means your surviving spouse or civil partner should receive the entire unused pension fund without the IHT deduction. It remains to be seen how this will work in practice.
This means whilst you can continue nominate others to receive the unused pension fund, you are unlikely to be able to use this means of IHT avoidance when conducting estate and Inheritance Tax planning from April 2027.
Restrictions on Agricultural and Business Property Relief
Agricultural and Business Property Reliefs were introduced to help the transmission of agricultural and business assets in family farms and businesses. That meant that agricultural and business property could be passed on without an IHT charge.
That is to chance from April 2026 when Agricultural and Business Property Relief will be restricted to the first £1 million of value. Any value about that will be charged at 50% of the IHT rate. This currently stands at 40% of the net estate above the nil-rate band.
The restriction of Agricultural and Business Property Relief could have significant financial implications for farms and businesses which are asset rich but cash poor. In such circumstances, it could lead to assets having to be sold to meet an Inheritance Tax bill. That might also lead to further Capital Gains Tax charges!
Estate and Inheritance Tax planning
If you have property, assets and investments of any significant value, it is essential to set up and continually review your estate and inheritance tax planning. There are specific steps you might be able to take to help mitigate the impact of IHT on your estate and take advantage of all the allowances available. Do not leave it until it is too late and set your loved ones up to have to meet a large Inheritance Tax bill!
Estate and Inheritance Tax planning solicitors, Glasgow and Livingston
Our solicitors have experience in dealing with estate and Inheritance Tax planning for clients and are able to advise on the options available. We provide this service from our offices in Glasgow and Livingston and deal with clients across Scotland.
If you have any questions on how to mitigate against IHT or wish to carry out a review of your Will and your estate and Inheritance Tax plans, please get in touch with us.