The IHT Tsunami
For many years, inheritance tax has been pushed to the margins of financial planning. Many families have not seen it as a serious threat to their wealth, largely because, with the right structures in place, it has often been possible to avoid or significantly reduce the charge. That position is now changing. The latest reforms to inheritance tax reliefs mean that assets which were previously protected may soon fall within the scope of the 40% inheritance tax charge. For many families, farmers and business owners, the result could feel less like a tax adjustment and more like a tsunami.
Summary
Inheritance tax planning is becoming more urgent as long-standing reliefs for agricultural assets, business assets and pensions are restricted. Families who previously expected to pass on wealth with little or no inheritance tax exposure may now face significant liabilities, particularly where assets are valuable but cashflow is limited. The key message is simple: review existing plans early, understand the potential exposure, and take advice before the new rules create unexpected pressure for the next generation.
Why inheritance tax has often been avoided
Under the inheritance tax regime, each individual has a nil-rate band of £325,000. In addition, where the family home passes to direct descendants, a residence nil-rate band of up to £175,000 may also be available. For married couples and civil partners, unused allowances can usually be transferred to the surviving spouse or civil partner. In practice, this has meant that most couples could pass on up to £1 million before inheritance tax became payable.
On top of those allowances, business relief, agricultural relief and the favourable inheritance tax treatment of pension schemes have historically protected substantial amounts of wealth from the 40% charge. Certain qualifying business assets have benefited from 100% relief, while pension funds have normally sat outside the inheritance tax net altogether. This combination has allowed many estates, particularly those involving farms, family businesses or substantial pension savings, to be passed on with little or no inheritance tax exposure.
What is changing?
The key issue is that reliefs which were previously available at 100% are being restricted. From April next year, certain qualifying business and agricultural assets that previously
qualified for full relief will only receive 50% relief. That means half of the value of those assets could become chargeable to inheritance tax on death.
Consider a farming couple with £1 million of other assets and £2 million of farmland. Under the previous regime, agricultural relief would usually have meant that the farmland was effectively ignored for inheritance tax purposes. Under the new rules, if only 50% relief is available, £1 million of that farmland value will be brought into the taxable estate. At a 40% inheritance tax rate, that would create a liability of £400,000.
Although inheritance tax can sometimes be paid by instalments, those instalments carry interest. For asset-rich but cash-poor families, particularly farms where annual returns can be low relative to land values, this could create a very real cashflow problem. In some cases, families may be forced to sell land, property or business assets simply to meet the tax bill.
Not just a farming problem
Much of the public debate has focused on agricultural land, but the implications are wider. Many family businesses will also be affected by the reduction in relief from 100% to 50%. Assets that were previously left out of the inheritance tax calculation may now be included, especially on the death of the surviving spouse or civil partner.
The consequences could be significant. In worst-case scenarios, family homes or business assets may need to be sold to fund inheritance tax liabilities. For family businesses, this is particularly concerning because the tax charge may arise at precisely the point when the next generation is trying to maintain continuity, protect jobs and preserve the value built up over many years.
Planning before the wave hits
The important point is that planning opportunities remain available, but families and business owners should not wait until the liability has already crystallised. Reviewing wills, ownership structures, succession plans, lifetime gifting strategies, insurance options and pension arrangements will become increasingly important.
The inheritance tax landscape is changing quickly. For those with farms, trading businesses, investment portfolios or substantial pension funds, the message is clear: do not assume that yesterday’s planning will survive tomorrow’s rules.
In the next few blogs, I will look at some of the strategies that may help families prepare before the IHT tsunami arrives.
David Mills
Partner