Discussions regarding Inheritance Tax (IHT) were once the sole preserve of ‘high net worth individuals’, namely those with significant capital or income living in the UK and liable to pay tax.
Richly decorated, wooden-panelled meeting rooms, home to polished oak tables and plush carpeting was where such discussions often took place, for IHT was a tax targeted primarily at the ‘rich’; as such, it was one potentially chunky tax liability almost all people could ignore.
IHT is actually a modified form of capital transfer tax, introduced by the Labour government in 1975; the renamed version came into existence in March 1986. In short, IHT is a tax on gifts made during the taxpayers’ lifetime and upon their estate when they die; the former are taxed at 20%, the latter at 40%.
Without going into masses of tax-related detail, suffice to say that the Finance Act of 2006 amended the IHT rules related to gifting, which, in turn, heralded a wholesale rethink of tax planning using trusts and wills. This amendment made the likelihood of average taxpayers being advised to establish trusts to avoid any IHT liability even more remote, particularly as one valuable exemption, transfers between married couples or civil partners, remain completely free of Inheritance Tax.
The status quo will remain in place for the time being at least, although the situation appears scheduled to change in the not-too-distant future following a government-led consultation which ended in late January after attracting a ‘substantial’ volume of responses to the government’s proposals, in particular from the pension industry.
Outline details of the proposed changes were revealed initially by the Chancellor Rachel Reeves in her October budget, when she announced the government’s intention to tax retirement savings with an aggregate value of more than £1 trillion. Further detail is promised, but it now appears very likely that a pivotal change to Inheritance Tax will be introduced in April 2027, ie less than two years hence.
The changes will hit those people who have saved into a private pension throughout their working lives and could affect those who have already retired. Most folks planned to use their self-funded pension income at some point, letting it continue to grow for as long as possible, while drawing upon other means of income, including the state pension, possibly topped up with the 25% tax-free lump sum allowed under existing pension legislation.
However, whereas private pensions, most of which are known as defined contribution pensions, were ultimately intended to be passed onto surviving family members, primarily adult offspring, and were not subject to Inheritance Tax, the rules are expected to change in April 2027. According to government proposals, any ‘unused’ money remaining in the defined contribution pension ‘pot’ could become liable to IHT.
To make matters worse, the Inheritance Tax threshold, frozen since 2009, will, in all probability, remain at its current level until 2030. Meanwhile, assets such as shares, which form the backbone of most pensions will, if the stock market experience of more than a century is any guide, continue to increase in value, so drawing more estates into the IHT net. One remarkable statistic shows how effective freezing the tax threshold can be: the level of IHT raised in 2023 was £7.4 billion; the following year, that figure had risen by almost 11% to £8.2 billion.
“Well,” you might say,” It couldn’t get any worse.” Unfortunately, this is incorrect. You see, if, upon death, pension funds become subject to Inheritance Tax (at 40%) after April 2027, the beneficiaries of what remains could, depending upon their income and tax banding, be liable to a further 27% in income tax, meaning that on a pension worth, say, £150,000, a whopping 67%, or £100,500, would go directly to the state in the form of taxes, leaving just £49,500.
When faced with the prospect of having what they believed would be a reasonable financial legacy left to their offspring and other family members* raided by the government, it’s hardly surprising that retirees have flipped their original financial planning on its head. ‘Spend now’ has become the new, grey-haired rallying cry as defined contribution pensions are used for holidays, new cars, kitchen extensions and other ‘fun’ items in order that remaining balances are not available to be used by Rachel Reeves, or her successor.
“Most people we speak with consider the pension-related proposals very unfair,” says Mark Gregory, Chief Executive Officer of Equity Release Supermarket, the UK’s largest independent equity release firm.
“As a consequence, while the government’s proposals are unlikely to become law until April 2027, the response from many people on the cusp of retirement, or who are already retired, has been decisive.
“An increasing number of people are intending to reduce the overall value of their estate while they’re still alive in order to ensure two things: first, they can gift an ‘early inheritance’ to their children or grandchildren and second, they can make the size of the bite the state takes from their remaining assets considerably lower.”
As it appears likely that retirees will be unable to bequeath as much as they would prefer to family members, many are taking the opportunity to use equity release to gift an early inheritance as a means of helping younger generations. The happiness and sense of personal satisfaction these gifts bring are priceless; helping an adult child onto the property ladder, or making a substantial contribution to an offspring’s wedding brings great joy.
And there is another ‘benefit’ equity release can offer. The majority of older homeowners who access the hidden wealth accumulated in their property, often over several decades, use a ‘lifetime mortgage’ for the purpose of releasing equity. As this mortgage is a liability secured against the homeowner’s property, it effectively reduces the estate’s value, leaving less for HMRC.
It’s worth noting that comprehensive details of the changes to IHT are yet to be revealed, but the warning signs are flashing red: in the eyes of some politicians, raiding pension funds is an easy means of adding hundreds of millions of pounds to the government’s departmental budgets. Exploring ways in which equity release could help you circumvent the forthcoming raid is the first step, although remember, this is not a solution suitable for everyone. It could, for example, result in you losing means tested benefits.
In the first instance, therefore, making an appointment to discuss the advantages and disadvantages of equity release with a qualified adviser makes enormous sense. It could represent an ideal opportunity to talk about your retirement options, although it’s unlikely that an exploratory chat will take place in a plush, wood-panelled meeting room…
The information provided in this article is for guidance only and does not constitute financial or tax advice. Equity Release Supermarket advisers specialise in equity release advice and do not offer advice on Inheritance Tax (IHT) planning or estate planning matters. For advice on IHT or other tax-related issues, we recommend consulting a suitably qualified financial adviser or tax specialist.
*Some transfers between married couples and civil partners are exempt from IHT.
