Tax year end is an extremely busy time for financial advisers, with a heavy focus on utilising various allowances before the opportunity has passed. In the midst of this frenetic, deadline driven period, we still need to keep one eye on the key financial planning considerations post 6th April. Once tax year end 2025 has passed, I suspect many advisers will be focused on strategies to mitigate the impact of pensions being brought into scope of Inheritance tax.
The proposal, currently still at consultation stage but likely to go ahead, will see unused pension funds subject to IHT as though they were part of the deceased pension scheme member’s estate from 6 April 2027. Although survivor’s pensions in defined benefits arrangements such as those used in the public sector will be out of scope of this legislation, very little else appears to be. So, this change promises to impact a broad spectrum of pension savers, and could have a significant impact on the financial plans of thousands of individuals taking financial advice.
The consultation on applying IHT to pensions closed on 22 January 2025, and the financial services and the legal industry awaits the consultation response to learn how all this will work in practice.
Assuming the proposals to bring pensions into scope of IHT go ahead, those clients who want to pass on wealth to their loved ones in a tax effective manner may want to increase their use of lifetime gifting. These gifts will either be exempt from IHT or potentially exempt, and if the donor then lives 7 years from the date of the gift, they become exempt.
So, it may be useful for advisers to refamiliarise themselves with the gifting exemptions available, which are immediately outside the estate for IHT purposes.
The obvious starting point is the spousal exemption. Transfers of assets between spouses and civil partners are usually exempt from IHT, and this will continue to be the case when pensions are bought into scope of IHT. So, upon death of a member, if the pension benefits are passed to the spouse or civil partner, this will rarely result in a charge to IHT. Furthermore, with the transferability of the IHT nil rate band (NRB), and the resident’s nil rate band (RNRB) relating to the primary residence, it is possible for the remaining spouse or civil partner to have an overall allowance of £1m before an IHT charge is due. It’s important to remember that the RNRB is only applicable if the property is passed to “lineal descendant’s” and that the RNRB is tapered or reduced at a rate of £1 for every £2 the net value of the estate exceeds £2m. Perhaps the key thing to be aware of here is transferability of NRB & RNRB does not apply to cohabiting couples, despite how common cohabitation is today. Given the rise in the use of income drawdown as a retirement income vehicle over the last decade, IHT on pension funds passing between cohabiting couples is likely to be a significant issue post April 2027. It will be interesting to see if the number of marriages increase as 2027 draws closer.
It is possible to make “small gifts” of up to £250 per annum to an unlimited number of people without these being subject to IHT. You can give as many gifts of up to £250 per person as you want each tax year, as long as you have not used another allowance on the same person. Birthday or Christmas gifts given from regular income are exempt from IHT. There is also a “gift allowance on marriage”, although the amount of the exempt gift depends on the relationship to the person receiving the gift. Individuals can make a gift exempt from IHT up to £5,000 for a child, £2,500 to a grandchild or Great-grandchild, and £1,000 to any other person. The marriage must take place for the exemption to apply.
There’s the annual gift allowance of up to a total of £3,000 p.a. that can go to anyone and any part of the annual exemption which isn’t used in the tax year can be carried forward to the following tax year. It can only be used in the following tax year and can’t be carried over any further. While it’s not possible to combine the small gifts allowance with other gift allowances to the same person, it would be possible to gift £5,000 to a child on their marriage and gift the same child a further £3,000 via the annual gift in the same tax year.
Gift to charities and political parties are exempt from IHT, and if 10% of the estate is gifted in this way, the IHT rate falls to 36% on the remaining estate.
An exemption not to overlook is “Gifting out of normal expenditure”. For this exemption to apply, this gift needs to be from income rather than capital, it must be regular, and it must not reduce the standard of living of the person making the gift.
If the proposal to levy IHT on unused pension fund on the death of a scheme member goes ahead as muted, we may see a significant increase in people raising the level of their pension withdrawals to gift the excess income above normal expenditure to reduce their estate. These gifts out of pension income may seem particularly attractive for scheme members approaching or already past age 75 due to the potential for double taxation. Where death occurs post age 75, current proposals would see IHT levied above the nil rate band on unused pension funds and then the beneficiaries paying tax at their marginal rate on the remainder of the benefits.
We have only covered the gifting exemptions in this article, and there are a multitude of other strategies that can help mitigate an IHT bill, but it’s important to remember the important role gifting exemptions can play in a comprehensive financial plan if passing on wealth is important to your clients.
Justin Corliss, Technical Team Manager, Royal London
