Estate Planning Post 2024 Budget and Beyond!
The recent Budget announcement on 30 October 2024 introduced significant changes to pension inheritance tax (IHT) rules which means there needs to be a greater emphasis on lifetime gifting into Trust and more effective frameworks on first death and less reliance on the spousal exemption.
From 6th April 2027, unused pension funds and death benefits will be included in an individual’s estate for IHT purposes with pension scheme administrators required to report and pay IHT to HMRC. The inclusion of pension funds will further increase the number of estates subject to IHT, making this a critical issue for many families. Consequently, immediate financial planning is advised.
Impact on Financial Planners and Clients
For years, pensions have been a primary tool for avoiding IHT, often outpacing their role as retirement funding mechanisms. Wealthy individuals have relied on pensions to pass assets tax-free to their families. However, the changes mean:
- For individuals aged 75 and older, pension death benefits could now face dual taxation: IHT on the total value and Income Tax when beneficiaries withdraw the funds.
- For those under 75, lump sum death benefits exceeding the Lump Sum Death Benefits Allowance (LSDBA) will also be subject to both taxes.
The spousal exemption remains, allowing pension and death benefit transfers to a surviving spouse or civil partner free of IHT. However, these funds will then be included in the spouse’s taxable estate.
Next Steps for Pension Savers
For individuals with significant pensions, particularly those exceeding retirement needs, new strategies are crucial:
- Reduce or Stop Pension Contributions: Cutting back on additional funding may prevent over-accumulation.
- Utilise Tax-Free Cash: Taking the 25% tax-free lump sum and gifting it to a Flexible Reversionary Interest Trust can make the funds IHT-free after seven years.
- Gifts from Income: Drawing taxable pension income to fund regular gifts into a similar Trust structure ensures immediate IHT exemption under the “gifts from income” exemption.
Additionally, including pensions in the taxable estate has profound implications for estates exceeding £2 million. The Residential Nil Rate Band (RNRB) tapers away by £1 for every £2 above this threshold, significantly increasing the IHT burden. Estates with high-value pensions and other assets may face compounded tax liabilities, emphasising the importance of proactive planning.
Timing and Planning Considerations
While the changes don’t take effect until 2027, planning should start now. The seven-year rule for gifting into Trusts requires prompt action to maximise benefits.
Trusts offer dual advantages: they can mitigate tax and protect family wealth from social impacts like divorce or creditor claims.
Practical Implications of the New Rules
Complexities in HMRC’s calculations could introduce challenges. These changes are anticipated to create further delays to the probate process as executors liaise with pension administrators.
Leveraging Trusts for IHT Planning
Flexible Reversionary Trusts offer a valuable solution. These Trusts allow individuals to transfer wealth without losing access to their assets. Gifts into these Trusts are Lifetime Chargeable Transfers, taxed at zero within the Nil Rate Band, with excess amounts taxed at 20%.
Over time, individuals can continue making gifts as their Nil Rate Band resets, every seven years. For instance, someone aged 70 could user and recycle their NRB multiple times within their life expectancy, maximising IHT benefits.
Additionally, Trusts accepting regular surplus income under the “gifts from normal expenditure” rules can provide immediate IHT relief. High earners can use these Trusts to shelter surplus income without impacting their standard of living.
What’s next?
The new IHT rules significantly impact pension planning, especially for those using pensions as IHT shelters. Trusts—particularly Flexible Reversionary Interest Trusts—offer an effective means of preserving wealth.
Clients with existing IHT liabilities should act now. Making use of lifetime gifting into Trusts to mitigate IHT while protecting and preserving family wealth intergenerationally.