What The UK Inheritance Tax (IHT) System Changes Mean for You
A Money Unspun guide to how the IHT changes announced in the autumn 2024 budget will affect estates and pensions.
In the autumn budget of October 2024, chancellor Rachel Reeves revealed some changes to the inheritance tax (IHT) system.
The first bit of news is that the UK government has decided to freeze the inheritance tax (IHT) thresholds until 2030.
This means the main allowances will stay the same, not increasing with inflation or property values as originally discussed. The following allowances will still stand.
- £325,000 (nil-rate band)
- An extra £175,000 if you’re passing on a family home to direct descendants
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Any amount above those thresholds will face a 40% IHT.
The government says the reason behind the changes is to make sure wealthier estates contribute a bit more to public funds. Most people still won’t pay IHT, but it’s likely to affect more families now, especially since inherited pensions will be subject to IHT from 2027 onwards.
HOW THE IHT CHANGES AFFECT PENSIONS
One of the big changes announced in October’s budget is that pensions will soon fall under the IHT system – from 2027 onwards.
Right now, pensions aren’t usually considered as part of someone’s estate for taxation purposes, so they’re mostly exempt from IHT. When the new ruling comes into play, pensions left behind will be taxed. The government says this could bring in an extra £1.5 billion a year by 2029.
This will have a big impact on how people plan their estates. Wealthier investors might need to start using their pensions differently.
For some, it’ll work out better to draw more income from pensions while they’re alive, rather than leaving large sums behind to be inherited and taxed. Some might even lean more towards annuities instead of drawdown plans to avoid those potential taxes.
If someone dies at or after age 75, any inherited pension funds are subject to the recipient’s income tax rate. So, beneficiaries could face both IHT and income tax on the same pension funds.
It’s also worth noting that pensions passed on to spouses will still be IHT-free, so there’s some protection there. But overall, it’s going to make inheritance planning more complex, especially for those with defined benefit pensions or larger pension pots.
Given that IHT receipts are at an all-time high – £7.3 billion last financial year – it’s a hot topic that’s likely to impact more estates in the coming years if values keep going up.
Fortunately, there are still ways to reduce tax liability, such as setting up trusts, using the seven-year gifting allowance, or taking advantage of spousal exemptions.
AN EXAMPLE OF THE NEW IHT RULES IN PRACTICE
Let’s say a person, Alice, 70 years old and single, passes away in 2027, leaving behind some assets.
- Savings: £75,000
- Home: £600,000 (which she’s leaving to her daughter)
- Pension pot: £200,000 (designated to her daughter)
CURRENT IHT RULES (BEFORE 2027)
Under the current rules, the pension wouldn’t be included in her estate for IHT purposes. This means Alice’s estate value for IHT would be just the savings and home.
- Total estate (for IHT): £75,000 + £600,000 = £675,000
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Now, she can use her IHT allowance.
- Nil-rate band: £325,000
- Residence nil-rate band (since the home goes to a direct descendant): £175,000
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Her total IHT-free allowance would be £500,000. So, under current rules, her taxable estate would be:
- Taxable estate = £675,000 – £500,000 = £175,000
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And the IHT payable would be:
- £175,000 x 40% = £70,000
NEW IHT RULES (FROM 2027)
Under the new rules, Alice’s pension pot is now included as part of her estate for IHT. Therefore, the calculation changes. Here’s how her estate looks with the pension included.
- Total estate (for IHT): £75,000 (savings) + £600,000 (home) + £200,000 (pension) = £875,000
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Her total IHT-free allowance remains the same.
- Total IHT-free allowance: £325,000 + £175,000 = £500,000
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Now, let’s calculate her taxable estate.
- Taxable estate = £875,000 – £500,000 = £375,000
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The new tax bill would be:
- £375,000 x 40% = £150,000 in IHT
IMPACT OF THE NEW RULES
Because of the inclusion of the pension in her estate, Alice’s family now faces an additional £80,000 in IHT (£150,000 – £70,000). If her daughter also falls into a higher income tax bracket, she may additionally owe income tax on withdrawals from the pension pot, adding further costs.
IHT RULE CHANGES FOR NON-DOMS
Starting from April 2025, the UK will no longer base IHT purely on domicile status. Instead, it’ll switch to a “residence-based” approach, which will pull more long-term UK residents, including non-doms, into the scope for IHT on their worldwide assets.
If a non-dom has been living in the UK for at least 10 out of the last 20 years, they’re considered “long-term residents” and subject to IHT on all their global assets. It’s not just UK assets anymore. This is a major shift, as it means their worldwide estate could be taxed upon their death.
Even if a non-dom leaves the UK after 10 years of residency, they’ll still remain under UK IHT rules for the next 10 years on all their assets. So, if they were to pass away within that 10-year window, their estate could still face UK IHT.
HOW THE IHT CHANGES AFFECT TRUSTS
For trusts like Excluded Property Trusts (EPTs), the picture is a bit more complex. If a non-dom has a trust holding non-UK assets, those assets could now face IHT charges if the settlor (the one who set up the trust) meets the 10-year residency rule.
In other words, if the person who created the trust has been in the UK long enough to fall under these new rules, then even the trust’s foreign assets could be hit by IHT.
If the settlor’s residency status changes, let’s say they leave the UK after meeting the 10-year rule, there may be an “exit charge” on trust assets at up to 6%.
For those who are already non-UK residents as of April 2025, there are some transitional rules. They won’t be subject to the new rules until they become UK residents again.
For instance, if someone has been out of the UK for more than ten years by 2025, their foreign assets would generally stay outside of the UK’s IHT scope unless they return.
The budget also made some changes related to agricultural and Business Property Relief (BPR). IHT relief on BPR will remain at 100%, but only up to a total of £1m. Any more than that and the rate will be reduced to 50%.
HOW THE IHT CHANGES AFFECT AIM STOCKS
The latest inheritance tax update means that AIM stocks (stocks listed on the UK’s Alternative Investment Market) are now looking at a 20% IHT charge, instead of being exempt.
The change is part of a bigger effort to raise funds, with the intention of bringing in up to £2 billion. However, AIM stocks still have a 50% tax relief on them, which has brought some relief to smaller investors in UK companies. There was a lot of talk that this relief might get scrapped entirely, so this outcome is a bit of a silver lining.
Abby Glennie, who manages the abrdn UK Smaller Companies fund, put it well. She said the government didn’t “throw in the hand grenade… that many expected.”
In other words, the news wasn’t as drastic as it could’ve been, and there was actually a slight bump in the AIM market right after the Chancellor’s announcement.
AIM stocks can play a good strategic role in portfolios, especially with their historic tax advantages, so it’s a bit of a balancing act. They’re still a solid option for those looking at inheritance tax planning, just now they come with a slightly higher tax bill than before.
MAKING INHERITANCE TAX LESS COMPLEX
UK IHT is complicated, especially as we’re going through a lot of updates to the system at the moment and the consultation is yet to be confirmed. It can really impact your estate and tax planning.
Seeking guidance from a financial advisor is a good move, as they can help you find ways to reduce your tax exposure and make the most of any available relief.
If you’re affected by the IHT or non-dom changes and looking for expert advice on how to protect your wealth, so you can pass as much of it as possible on to your loved ones, then contact us today.
