Inheritance tax giving

As a brief re-cap a host of changes were announced in the Autumn Budget of 2024 that involved:

• Reforms to domicile (now “long-term residence”) from April 2025

• Introduction of limits to Agricultural and Business Property Relief from April 2026

• An IHT charge on unused pension funds proposed from April 2027

For many these changes will mean that any previous IHT advice now needs to be revisited, and with the pension changes in particular, we expect a lot of people will be brought into the scope for IHT for the first time.

If an individual finds that their net assets (their “estate”) is subject to IHT then planning typically involves spending money or giving it away.  We are seeing a real increase in lifetime gifts as a result of the 2026 and 2027 changes to IHT and here we discuss a few key concepts.

What is lifetime giving?

Lifetime giving is where an individual gives away an asset (such as cash) to another person, such as their children or grandchildren.  Lifetime gifts fall into one of three categories for IHT:

• Exempt gifts.  Gifts within prescribed annual limits are automatically exempt and whilst most of these are small in value, this does include gifts of surplus income.  It also covers gifts between married couples and civil partners, and gifts to charity.

• Immediately chargeable gifts.  Gifts to a trust (or less commonly to a company) are immediately chargeable to IHT at a lifetime rate of 20%.  The tax on such gifts can increase if the donor dies within 7 years of the gift being made.

• Potentially exempt gifts (PETs).  Gifts which are not caught as either of the above, are ‘potentially’ exempt.  This means that no IHT is payable on the gift at the time it is made, but IHT may be chargeable if the donor dies within the following 7 years.

It should be remembered that where an individual makes a gift to someone other than their spouse or civil partner, then capital gains tax may arise.  This is a topic in itself but broadly gifts of cash do not incur capital gains tax but gifts of most other assets (such as investments or property) does.  It may be possible to claim something known as ‘holdover relief’ to defer the capital gains tax charge if the gift is of a qualifying business asset, or the gift is to a trust and therefore immediately chargeable to IHT.

It should also be remembered that if an individual gives away an asset but continues to use it or benefit from it then generally IHT will still arise as if the individual never made the gift.  There are some exceptions to this, and where that ‘reservation of benefit’ ceases then generally it will take 7 years after that cessation to leave the IHT estate.

Agricultural and business assets

Certain assets used in a qualifying business activity, or for the purposes of agriculture, may qualify for relief from IHT when the owner of those assets dies.  Until April 2026 there was no overall limit on how much relief could be given to qualifying assets, but for deaths from 6 April 2026 there is now a general £2.5m limit for full relief (i.e. at 100% of the asset value) at which point only half of the asset value attracts relief.

In anticipation of the April 2026 changes a large number of business owners made gifts to the next generation or their chosen beneficiaries to make use of the unlimited relief, whether directly or into a trust.  This was particularly relevant to owners of businesses that had no intention of selling them (quite common in farming family arrangements, for example) where the original plan had been to transfer the assets on death, via their Will, as no tax would arise.  Business owners who have yet to take advice on this should still do so as lifetime gifts can continue to be made to mitigate the IHT exposure on their business on death, and very often this will be via PETs or immediately chargeable gifts to a trust.

Pensions

The introduction of unused pension funds to the IHT estate for deaths from 6 April 2027 will completely change the outlook of IHT for many.  Those who had taken appropriate financial advice may have been actively retaining funds in their pension so that they could pass IHT free to their chosen beneficiaries on death, and this may require a re-think.

It is worth making two points very clear when discussing pension funds and the changes to IHT from April 2027.  The first is that the changes are not yet in place and we could see amendments to the legislation between now and when they become law – caution is needed when making decisions based on rules which are not yet in force.  The second is that assets like pension funds almost certainly require financial advice alongside tax advice, before any decisions are made or action is taken.

The introduction of IHT to unused pension funds could result in some very significant tax charges, as in most cases income tax will still be payable when extracting funds from the pension.  A typical example would be an individual leaving a pension fund at death to their child, where 40% IHT could be payable on the value of the pension pot.  When that child accesses the funds this may be treated as pension income, and taxed at that individual’s marginal rate, which could be as high as 45%.  In the simplest example the overall tax could be 67% of the pension funds held at death!

This could be seen as an incentive to spend pension funds in retirement (perhaps what they were originally designed for) and to consider giving away other assets if IHT has become a problem.  This may not be straightforward for those who have deliberately built-up pension funds and spent other savings because of the IHT exemption that applies to the pension before April 2027.  Again, these comments are made solely from a tax perspective and financial advice is also key to any decision making.

Pensions and lifetime giving

There is no single solution that will apply to everyone with unused pension funds, who do not wish to spend them (or cannot spend them in full), but a common concept being considered at this time is to try and limit the tax to a single charge.  For example, if the owner of the pension extracts it all then income tax is paid (barring any available tax free lump sum).  By giving the net pension funds away during lifetime, that may be the end of the tax charges.  If that gift is a ‘PET’ then the donor will need to survive for 7 years after making it to escape the IHT charge.

This is where an exemption for ‘gifts out of surplus income’ is very useful as qualifying gifts are immediately exempt from IHT and do not require the donor to survive 7 years.  The extraction of pension funds is “income” and therefore may be surplus to the individual’s needs if they have no need for the additional income in order maintain their lifestyle.  Specific advice is often required to ensure the IHT exemption is available and this may require an analysis of the individual’s net income, the gifts intended to be made, and the mechanics of how those gifts are made, in order to satisfy HMRC’s requirements.