The effect of Rachel Reeves’ budget on inheritance – and charity legacies

We all knew that Inheritance Tax was going to be changed at the budget.  The government had an opportunity to overhaul a complicated system, but sadly it, once again, decided to tinker around some the tax-free elements and retain the existing tax-free allowances.  Inheritance tax can be planned for and including a charity donation can continue to reduce the rate of inheritance tax payable (from 40% to 36%) and support a worthwhile cause. 

Tax Free Allowances

We all have an inheritance tax-free allowance of £325,000 (called the Nil Rate Band).  This is remaining in place and won’t increase until at least April 2030.

If you are a home owner and have direct descendants, then you may qualify for a further inheritance tax free allowance of £175,000 if your estate is below £2million.  Again, this allowance is remaining in place and frozen until 2030.

If you are a married or in a civil partnership you can effectively pass up to £1million to the next generation and not pay inheritance tax.  The majority of estates don’t pay any inheritance tax.

When asset pass to a spouse or civil partner, remember they pass tax free.  This is known as the spousal exemption.

Changes to Pensions

Up to now, those who have a pension that will have a value on death and can be passed on to someone else, is not part of the estate value for inheritance tax purposes.  From April 2027 the value of these pensions will form part of the estate for inheritance tax purposes.  Inheritance tax will be payable when passed to anyone other than a spouse or civil partner, as the spousal exemption still applies.

Example:

Jack had savings worth £50,000, a home worth £400,000 and a defined contribution pension pot of £100,000.

He has a total estate worth £550,000 and it will be inherited by his daughter Samantha.

Under the current rules, Jack’s estate would have no IHT to pay, as the pension could be inherited tax-free, and the rest of his estate is under the £500,000 IHT allowance (£325,000 plus the extra £175,000 as he’s passing on his home to his direct descendants).

Under the new rules, Jack’s estate would have a £20,000 IHT bill to pay – as his total estate is £50,000 above his IHT allowance (that £50,000 would be taxed at 40%).

This will potentially include death in service payments from employers if the payment falls under pension scheme rules.  This is the lump sum payment made to loved ones if an employee dies during their term of employment.  Many schemes do fall under these rules at present.  There is, however, plenty of time to plan for this and there are other options available for those people affected.

Changes to Business and Agricultural Relief

Certain assets have been exempted from inheritance tax:  business assets and farm land and farming assets.  This is known as Business Property Relief (BPR) and Agricultural Property Relief (APR).  This will change from April 2027 and each individual will be able to only pass on £1million worth of BPR and APR assets.  Any excess over this will be taxed at 50%.

Example:

John has a farm worth £3million and he is intending on passing it to his daughter Sarah.  Under current rules with his inheritance tax free allowances of BPR and APR available no tax is payable.  Under the new rules up to £2million will be tax free but the remaining £1million will be subject to inheritance tax at 20%.  Therefore, there is a potential inheritance tax bill of £200,000 on John’s death.

If you have invested in smaller companies as part of your inheritance tax planning, e.g. AIM Portfolio, then the rate of BPR your estate can qualify for has been reduced.  Previously, no inheritance tax would be payable on these shares so long as they have been held for 2 years.

Now they will be subject to inheritance tax but at a rate of 20% instead of 40%.

Example:

Louise has an AIM portfolio of £100,000, the rest of her estate is valued at £500,000. She plans to gift her estate to her son James.   Under the current rules, no inheritance tax will be payable, but under the new rules her estate will have to pay inheritance tax of £20,000.

Inheritance tax is the one tax that can be planned for.  There are ways to mitigate it with some forethought and planning, and including a donation to Hammersley Homes in your Will not only reduces your potential tax bill but supports a cause that is close to all our hearts.