Ramifications of the Autumn Budget

It is apparent some groups have been particularly hit hard. Media headlines are still revealing the impact but business in general is coming to terms with increases in the minimum wage and National Insurance thresholds and rates, alongside reforms to some working practices.

On top of that, business owners have seen significant changes to the Inheritance Tax treatment of their business interests, with a particular impact on farming and business families. If you are in business or know someone who is considering what the changes might mean for them, our specialist business and rural teams may be able to help. Our rural team did write shortly after the Budget on some of the challenges facing agricultural businesses which you can read here.

The consequences of some of the Budget announcements for individuals are also potentially significant making it even more important that financial positions are regularly reviewed so planning can be updated and where necessary adjusted to take account of the changing tax landscape.  For our part, we remain committed to working with you to ensure you structure your affairs as effectively as possible.

While the main rules of Inheritance Tax (IHT) were left untouched, certain areas including Business Property Relief (BPR) and Agricultural Property Relief (APR) both saw major reform.

Agricultural Property Relief (APR) and Business Property Relief (BPR)

Under current rules, assets that qualify for 100% BPR or APR have an unlimited amount of benefit. The original intention of these reliefs was to avoid the breakup of a family business on the death of an owner if their beneficiaries had to sell assets to pay the IHT due. It is a valuable relief and the IHT savings on large estates can run into £millions at present.

In the Budget, it was announced from 6 April 2026, there will be a new £1 million allowance introduced. This will be a combined benefit between agricultural and business property with any excess above this limit qualifying for relief at the lower level of 50%, a tax rate of 20%.

For example, if an individual owns £1 million of assets that currently qualify for 100% APR and £1 million of assets that qualify for 100% BPR, on death after 5 April 2026 those assets will be combined so £1 million would get 100% relief from tax and the remaining £1 million would only get 50% relief. The result is an increase in IHT from zero to £200,000.

This reduction in the allowance could have significant and wide-ranging implications on some estates and will require some careful planning to try and mitigate the impact. The new allowance is still at an early stage with a technical consultation due to be published in early 2025 to provide additional details and draft legislation. Once we have this, we will be in a better position to consider what planning will be possible.

Transfers after budget day

As the changes will only affect deaths occurring after 5 April 2026, there is still time to plan and make transfers of assets. This is a complicated area, and we would urge you to take professional advice before taking any action. New rules were included alongside the Budget so if you transfer agricultural or business property on or after Budget day and die on or after 6 April 2026 and within 7 years of transfer, the new £1 million allowance will still apply.

It is also important to consider the Capital Gains Tax (CGT) consequences of transfers. The transfer of assets is typically a disposal for CGT purposes so transferring will cause any gain on the assets to become chargeable and, consequently, there could be a significant CGT liability to consider.

It may be possible to defer this tax for business assets by ‘holding over’ the gain to an individual or a trust but this is a complicated area and professional advice should be taken if you are considering this.

Reception

The new APR / BPR limit of £1 million has been widely criticised as being too low.

While there is still 50% relief above the £1 million limit, it could still have a destabilising impact on businesses above this level. We will certainly see business groups lobbying the Government to raise the limit before legislation is finalised.

Proposals have been made to bring pension funds into estates for Inheritance Tax purposes for deaths occurring on or after 6 April 2027. A Government consultation was launched explaining how the changes proposed would ensure that tax reliefs on pensions are being used for their intended primary purpose – to encourage saving for retirement and later life.

Until the legislation is published, we cannot be certain how the final rules will look and until then, the current rules will continue to apply. It is difficult to give specific advice at this early stage but below we have given more detail in simple terms of what we believe will be the tax treatment of your pension fund on death post-April 2027.

Inheritance Tax (IHT)

IHT will be payable on the value of your pension fund immediately before death. The IHT charge will need to be calculated by the pension scheme administrators and held back before funds are distributed or designated to beneficiaries. The scheme administrators will pay any IHT due directly to HMRC.

The process will require the personal representatives and the pension scheme administrator/trustee having to work together to establish the IHT charge and the proportion of the charge the pension scheme must pay.

As an example, consider an estate of £2 million which includes a pension fund of £1 million for an individual with no spouse and no children. They have an IHT nil rate band of £325,000 which will be shared equally between the free estate and the pension fund. The personal representatives contact the pension scheme administrators and agree that the IHT nil rate band will be split equally between the free estate and the pension fund.

The pension administrators ignore the half share of the nil rate band (£162,500) and apply 40% IHT to the remainder. £1 million – £162,500 = £837,500 x 40% = £335,000 IHT for the pension scheme to pay to HMRC.

This leaves £665,000 in the pension fund to be distributed according to the deceased’s wishes.

Spousal exemption

Spousal exemption will work in the normal way so if your spouse or civil partner is nominated for the entire pension benefit, there should not be an IHT charge on first death at least.

In the example above, if there was a surviving spouse or civil partner there would be no charge to IHT on the first death. Tax is still likely to be payable on the spouse’s death.

Existing pension tax charges

Although pension funds currently are not subject to Inheritance Tax, they can be subject to other pension charges when benefits are drawn by beneficiaries which we believe may continue to apply post-April 2027 in addition to any IHT charge.

At the present time, we understand IHT will be calculated and charged before any existing tax charges are applied. Broadly this means there will be a difference depending on whether you die before or after age 75 and who your death benefit goes to. Put simply, unless your pension is nominated to your spouse, the fund available to be distributed could be reduced by up to 40%.

If you die before your 75^th birthday

Existing tax charges will continue to apply so there could be additional tax due for those below 75 who elect to take a lump sum death benefit above the Lump Sum and Death Benefits Allowance (LSDBA). The standard LSDBA is £1,073,100 but higher figures may be possible if pension protection is in place. There should be no additional tax charges where benefits are taken in the form of a beneficiary’s drawdown plan.

The table below isn’t exhaustive but covers the tax charge for most scenarios.

After your 75^th birthday

For deaths occurring after age 75, where benefits are transferred to a beneficiary drawdown plan, any funds subsequently withdrawn will suffer Income Tax in the hands of the beneficiary at their own marginal rate of Income Tax.

Rather than the death benefit being payable to a drawdown plan, there is also the option for a lump sum to be paid. Where a lump sum payment is made to an individual, there is a marginal rate tax charge on the recipient of up to 45%, which including the IHT can mean a total tax charge of up to 67%. The table below shows the effective tax rate, depending on the beneficiaries tax rate, of how we understand IHT and then pension tax will be applied to a pension fund.

So, depending on the marginal tax rate of the beneficiaries, it may be better to use beneficiary drawdown where there is no pension tax on transfer and tax is only applied when withdrawals are taken.

A lump sum can also be paid into a discretionary trust at the trust’s marginal tax rate of 45%. Subsequent distributions from the trust to beneficiaries are paid with a 45% tax credit so those with lower rates of tax can reclaim tax paid.

Impact on your estate

There are unanswered questions about the interaction with estate planning in general. For those with estates over £2 million the Residence Nil Rate Band (RNRB) is reduced by £1 for every £2 above this limit. So, for an individual’s estate above £2,350,000 the £175,000 RNIB is removed completely. Similarly, a couples RNRB of £350,000 will be lost on estates over £2,700,000.

Our current assumption is that pension funds would be included in the estate for this calculation. In certain situations this could lead to an effective additional tax rate after 5 April 2027 of over 90%.

What next?

There has been much talk in the media of the unfairness of ‘double’ taxation of IHT and possible pension charges on top for those with large funds above the Lump Sum and Death Benefit Allowance (LSDBA) (in full) who die before 75 and for those who die after 75.

While the current rules remain in place until April 2027, you may not want to disturb your current arrangements for dealing with your pension fund on death. For those who are likely to draw on their funds significantly to support their retirement income requirements, these changes are likely to have less impact. For those who do not require their pension funds to generate their income, these changes are potentially very significant and how this can be managed will require very careful consideration once the rules have been published.  In all cases, the implications of this change will need to be factored into your planning.

Starting to draw upon your pension

If you are over the age of 55 (rising to 57 from April 2028) you can start drawing on your pension fund, with a tax-free lump sum of usually 25% of the fund value (within limits) and any income received is simply taxed at your marginal rate of Income Tax.

For anyone who is a non-taxpayer or pays tax at the basic rate and, especially those over the age of 75, it may now be beneficial to start drawing income ahead of the changes in April 2027 provided it remains taxable still at the basic rate. The result being that more of the pension fund could be taxed at a lower tax rate than 40% plus potentially pension charges on top in some cases.

If you have reached the age of 75 and not yet drawn your tax-free lump sum, then it is likely to be sensible to take this before the changes in 2027 as the tax-free treatment is lost on death. Whilst the lump sum may be liable to IHT at 40% in your estate, it will avoid additionally incurring pension charges as well which would see an overall effective tax rate of 67%.

Pension nominations

It is likely all pensions and death benefit nominations will need to be reviewed over time but especially for those who have earmarked their pensions for estate planning purposes.

For those with a spouse or civil partner, it is likely to become the default that they are nominated to avoid an IHT charge on the first to die. This will avoid unnecessarily using tax-free nil rate bands that may otherwise be used by the survivor on the second death.

Certain situations are going to be more difficult to manage, particularly where pensions have been used to plan for complex families – perhaps where a second spouse is gifted assets, but pension funds are earmarked for children from a first marriage or farming families where one child has been gifted the farm and the pension nominated for other non-farming children by way of compensation.

Death in service schemes

There has been speculation in the press about the taxation of life assurance schemes designed to pay out a multiple of an employee’s salary if they die before retirement. These are often set up within a pension wrapper and, currently, the benefit payable is not subject to IHT. There is a possibility that such schemes may be included in these changes.

The technical consultation on the changes did state ‘All life policy products purchased with pension funds or alongside them as part of a pension package offered by an employer are not in scope of the changes in this consultation document.’ We hope this means that these schemes will not be taxed but clarification will be needed.

Defined benefit (Final Salary) schemes

The taxation of defined benefit schemes can vary depending on the scheme rules and some death benefit payments are already subject to IHT. From 2027 any payments to spouses or civil partners on death will not have IHT applied. Payments made to others may have IHT applied after April 2027.

Summary

There has long been an argument for a set of consistent rules for pension schemes as this gives people confidence to plan for the future. While some of the proposed changes are understandable from a tax point of view, the cliff-edge implementation in 2027 will have serious consequences for some who had planned within the existing rules.

The inclusion of pension funds within estates for IHT purposes is potentially very complex and as a consequence, it also seems that the job of personal representatives will get more onerous with the need to deal with pension companies and arrange for them to settle tax liabilities. Our estate administration service is available to make this job a little easier for your loved ones on your death and we will be writing about the benefits of this service in a future Insight.

Once the final legislation on the Budget proposals is published, we think that many of you will need to review your financial position to understand the impact of these changes on your own circumstances. They are a potential minefield making it more important than ever for people to take advice on how best to navigate the changes to reduce the potential impact.

If you have any questions, or want to discuss your individual circumstances with an Old Mill financial expert, please do get in touch by clicking here…