The recent UK Budget has introduced significant changes to inheritance tax (IHT) that will impact retirees, especially those with substantial estates and complex assets like defined contribution (DC) pensions, business interests, and Alternative Investment Market (AIM) shares. Here’s a breakdown of the updates and their implications for retirees, along with planning strategies to mitigate the impact on inheritance tax.
Defined Contribution Pensions and Inheritance Tax
One of the headline changes is that defined contribution (DC) pensions will now be subject to IHT from April 2027. Previously, retirees could leave untouched pension funds outside their estate’s IHT liability, allowing funds to be passed to beneficiaries tax-free upon death. Now, however, pension funds will be counted alongside other assets, and if the total estate surpasses £325,000, a 40% tax will be applied on the excess. This change alters the logic behind leaving pensions untouched, as they now contribute to IHT calculations.
Defined benefit (DB) pensions are exempt from this change due to their structure, where benefits are not directly transferrable. Nonetheless, this shift means retirees with DC pensions will likely consider withdrawing funds earlier or seeking other tax-free vehicles, such as ISAs, to protect assets. Retirees may also start prioritising ISAs, or spending down pension funds, both to avoid IHT and to ensure their estates can benefit from more flexible, tax-efficient instruments.
Frozen Inheritance Tax Thresholds
The Budget extends the freeze on IHT thresholds until 2030, a decision set to raise additional revenue as asset prices continue to rise. The nil-rate band (£325,000) and the residence nil-rate band (up to £175,000) remain in place, meaning estates below £1 million can still be transferred tax-free to children or grandchildren if a family home is included. However, with asset inflation pushing more estates above these thresholds, even more families will face substantial IHT bills. Experts anticipate this will affect middle-income estates especially, where pension savings, property, and investments may now push them above the threshold.
Changes to Business Relief and Agricultural Relief
The government’s adjustments to business and agricultural reliefs are another crucial aspect of the Budget. From April 2026, business relief and agricultural relief will only fully apply to the first £1 million of combined business and agricultural assets. For assets beyond this threshold, only 50% relief will be available, effectively subjecting them to a 20% IHT rate. Previously, business and agricultural property could be transferred with complete IHT relief if certain conditions were met, which allowed family-owned businesses and farms to pass from one generation to another with little to no tax impact.
The new cap introduces a significant tax liability for wealthier estates, particularly those involving larger businesses or agricultural operations. This adjustment reflects the government’s aim to close perceived “loopholes” that some have criticised as overly generous to wealthy families. This also creates a new consideration for families looking to pass on their business assets, as they may need to explore trusts, family investment companies, or other structures to help mitigate tax on assets above the new relief threshold.
Alternative Investment Market (AIM) Shares and Planning Implications
Many retirees use AIM shares in IHT planning due to their qualification for Business Relief, allowing them to be passed on free of IHT if held for more than two years. AIM shares have gained popularity due to their dual benefit of potential high returns and tax efficiency. The UK Budget on 30 October 2024 has introduced significant changes to AIM shares and inheritance tax (IHT) planning, especially for retirees with substantial estates. AIM shares, previously exempt from IHT after a two-year holding period, will now incur a 20% IHT rate, reducing their tax efficiency as an estate planning tool. This policy shift adds new costs for AIM investments and will likely influence allocations toward more tax-efficient vehicles. Additionally, the government has frozen ISA allowances until 2030, impacting tax-free investment options for high-net-worth individuals.
Planning Strategies for Retirees
For retirees, these IHT reforms demand careful re-evaluation of their financial and estate plans. With pensions now potentially within the tax net, retirees may look to draw down pension funds during retirement and gift the excess income using the “normal expenditure out of income” rules rather than leaving them untouched. Doing so could allow them to pass on other, non-taxable assets to beneficiaries instead. This is, however, effectively volunteering to take the tax hit in the form of Income Tax during one’s lifetime rather than IHT post-death – a difficult decision for higher (40%) and additional-rate (45%) taxpayers.
ISA Allowances and Their Role in Estate Planning
While ISAs have favourable tax treatment for income and capital gains during one’s lifetime, they do form part of the taxable estate upon death. This year’s Budget extends the ISA allowance freeze to 2030, limiting future contributions. While ISAs do not offer IHT relief, they remain a valuable income tool, especially as pensions become less tax-efficient upon death. Retirees will need to carefully weigh the merits of ISAs for accessible income against their inclusion in the taxable estate.
Leveraging Trusts for Estate Management
In light of these changes, trusts provide a valuable tool for managing IHT liabilities while enabling control over asset distribution. Assets transferred to a trust are generally removed from the estate after seven years, avoiding IHT. Trusts like discretionary or bare trusts allow retirees to specify conditions for fund use, securing family wealth in a tax-efficient structure. However, they require early planning and potentially incur some charges depending on the type and value of assets transferred. Retirees interested in trusts should consult advisers to ensure compliance with evolving regulations and alignment with family financial goals. Families with rising asset values may be nudged to reassess their wills, trusts, and potential gifts to manage future tax obligations. Business owners and farmers with larger estates may seek specialised advice to leverage available reliefs or explore new vehicles to maintain tax efficiency.
Balancing ISAs, Pensions, and Trusts in a Holistic Strategy
With these Budget updates, retirees should aim for a multi-pronged strategy, balancing ISAs for tax-free income, drawing down pensions early to avoid IHT, and exploring trusts for legacy assets. This approach can help retirees achieve tax efficiency while ensuring wealth transfer aligns with both family needs and regulatory requirements. Using ISAs as an income stream during retirement, for instance, may allow retirees to draw less from pensions, thus reducing overall estate value. Similarly, gradually transferring high-value assets into a trust provides control and can mitigate future IHT exposure if planned well ahead.
Importance of Regular Reviews and Professional Guidance
The latest Budget signals a stronger emphasis on taxing generational wealth, requiring retirees to adopt more nuanced estate strategies. With proactive planning, retirees can still achieve tax-efficient wealth transfer that meets personal and family needs.
Given the government’s intent to reduce tax avoidance through increased IHT scope, retirees should review estate plans regularly. Financial advisers can help tailor strategies to fit within the new rules, leveraging IHT reliefs and tax-efficient investments across pensions, ISAs, and trusts. Retirees may need to adjust existing estate structures or revisit investment priorities, especially if AIM shares or high-value business assets are part of the estate.
In light of the government’s drive to close IHT “loopholes,” these changes represent a shift towards broadening the tax base. This Budget has redefined the strategic use of pensions, business assets, and AIM shares, calling for updated estate plans that reflect both the new IHT parameters and a changing investment landscape.
Several changes from the 2024 Budget will likely require amendments to the Finance Act to implement the new inheritance tax (IHT) policies effectively. These include:
- Inclusion of Defined Contribution Pensions in IHT: The extension of IHT to DC pensions (from April 2027) will require legislative amendments to clarify when pension values are included in estate valuations for tax purposes.
- Modification of Business and Agricultural Reliefs: Limiting relief to the first £1 million of business and agricultural assets, with a 50% relief rate on the remainder, introduces a new threshold requiring clear legislative definitions and application rules.
- Changes to AIM Shares’ IHT Exemption: Removing the IHT exemption for AIM shares and applying a 20% rate necessitates specific revisions in the Finance Act to set consistent rules around these securities.
These adjustments will require precise legislative language to address asset valuations, transfer conditions, and specific exemptions to avoid ambiguity and ensure compliance. Some of these proposals could well change, be watered down, or subject to transitional rules. It’s therefore important not to act hastily, as we saw some people do before the Budget, due to the unprecedented levels of rumour and speculation.
Financial advisers are likely to play a pivotal role in guiding retirees through this evolving landscape, with options to maintain control over their wealth while minimising tax impacts for future generations.
Please note:
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.