George Square’s expert independent financial advisers provide updated insights into common questions about inheritance tax (IHT), including recent changes to how pensions will be treated for IHT purposes starting in 2027.
What is IHT and when is it applied?
Inheritance tax (IHT) is a 40% tax on the estate of someone who has died, including property, possessions, and money. It is charged only on the part of the estate exceeding the tax-free threshold, currently set at £325,000. With careful planning, the amount of IHT payable can often be reduced.
Can you pass on unused threshold?
If a spouse or civil partner dies without using their full £325,000 threshold, any unused portion can be transferred to the surviving partner. This means the tax-free allowance can reach up to £650,000 for a married or civil-partnered couple, if neither has used their £325,000 allowance at the time of the first partner’s death.
What is the residence nil-rate band?
The residence nil-rate band provides an additional allowance of £175,000 for homeowners who leave their primary residence to direct descendants, such as children or grandchildren. This amount is transferable, meaning that when combined with the £325,000 threshold, a married couple can potentially pass on up to £1 million tax-free.
Why is having a will important for IHT planning?
Dying without a will (intestate) can limit IHT exemptions that exist for spouses or registered civil partners. Without a will, other relatives may be entitled to a share of the estate, potentially triggering an IHT liability. Read more about how a will can help reduce your IHT due here.
Are pensions exempt from inheritance tax?
Currently, pensions are generally exempt from IHT. The treatment depends on your age at death:
- If you die before age 75: Your pension can be inherited tax-free by beneficiaries.
- If you die aged 75 or above: Beneficiaries pay income tax on pension withdrawals at their tax rate.
However, as announced in the recent Budget, from April 2027, unspent pension funds will be subject to IHT and counted as part of the deceased’s estate. This change means pensions will be included alongside other assets in calculating whether IHT is payable.
Here’s an example of how the updated rules will apply:
If you pass away at age 73 with an estate of £550,000, made up of:
- £50,000 in savings,
- A home valued at £400,000 left to your child, and
- A pension pot of £100,000.
Under current rules, your estate would have no IHT liability, as the pension is IHT-exempt and the rest falls within your £500,000 IHT allowance. Under the 2027 rules, however, the pension would count toward IHT, resulting in a £20,000 IHT bill, as your estate is £50,000 over the threshold (taxed at 40%).
IHT and income tax on inherited pensions
The government has retained the age-based income tax rules for inherited pensions:
- If you die under age 75: Beneficiaries pay no income tax on inherited pensions after IHT is deducted.
- If you die at age 75 or above: In addition to IHT, beneficiaries will also pay income tax on inherited pensions at their own tax rate.
How can I reduce my IHT liability?
There are several ways to reduce IHT liability with strategic estate planning:
- Gift allowances: Each individual can gift up to £3,000 annually without IHT. This allowance can carry forward for one year, allowing a couple to gift up to £6,000 per year. Small gifts up to £250 per person are also exempt from IHT, provided no other gifts are given to that individual within the same year.
- Assets exempt from IHT: Certain gifts and property transfers, like charitable donations and wedding gifts, are IHT-exempt. Business Relief (BR) may also apply to qualifying business assets.
- Life assurance in trust: Placing a life assurance policy in trust keeps its payout separate from your estate’s valuation, helping shield it from IHT.
- Wealth within a pension: As pensions are now included in IHT from 2027, consider managing withdrawals carefully to avoid adding to your estate’s taxable value.
- Charitable legacy: Leaving a portion of your estate to charity can reduce your IHT rate from 40% to 36% if you donate 10% or more of your estate’s value.
IHT tax-free threshold frozen until 2030
The IHT tax-free threshold of £325,000 will remain frozen until April 2030, extending the prior freeze set to end in 2028. This frozen threshold may mean an increase in IHT liabilities for some estates due to inflation and rising asset values.
Get in touch
Inheritance tax planning depends heavily on individual circumstances. Our experienced advisers at George Square Financial Management can help you organise your affairs in a tax-efficient way, adapting your plan to these recent changes in IHT rules.
Call us on 0115 947 5545 to arrange a free initial consultation or send us a message here.