Inheritance tax reforms to hit business owners and farmers

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Significant alterations to the UK's inheritance tax system revealed in Wednesday's Budget will greatly affect business and farm owners, along with individuals holding pensions.

Important changes impacting these groups consist of a halt on the tax-free limit, limitations on essential reliefs, and the inclusion of pensions in the inheritance tax framework.

Chancellor Rachel Reeves declared that the exemption limit for inheritance tax will remain frozen until 2030, extending its current freeze that was set to end in 2028.

Since 2009, the nil-rate band has remained fixed at £325,000, instead of increasing annually to keep pace with inflation.

Reeves also confirmed that the freeze on the residence nil-rate band, which allows an extra £175,000 when leaving the main home to direct descendants, will be extended for an additional two years.

Starting in April 2026, complete relief will be limited to business and agricultural assets valued at over £1 million.

Assets above that threshold will qualify for a 50 percent reduction, leading to a real tax rate of 20 percent for those who inherit them.

Nonetheless, these assets will continue to take advantage of the nil-rate band and the residence nil-rate band. The government has indicated that only the most affluent estates would be impacted.

However, experts cautioned that the changes in the Budget could lead to financial and operational difficulties for individuals looking to transfer ownership of their businesses and farms.

James Ward, partner and leader of the private client team at Kingsley Napley, stated that cutting back on agricultural property relief and business property relief will result in significant inheritance tax bills for individuals inheriting estates. This could potentially impact investments in the business and, in certain situations, threaten the overall sustainability of the operation when it is transferred after someone's death.

Ian Dyall, who leads estate planning at the wealth management company Evelyn Partners, mentioned: “Although this action is not as drastic as some anticipated, it's still likely that small family-owned businesses could be affected by measures aimed at the wealthiest families.”

Reeves also revealed plans to eliminate the exemption on inheritance tax for pension funds starting in April 2027. This change is expected to raise around £1.46 billion by the 2029-30 fiscal year, representing a significant change in how affluent individuals will approach their retirement strategies.

After the government eliminated the lifetime allowance on pension pots exceeding £1,073,100 in 2023, the role of pensions in retirement planning has sparked significant worry among officials.

If a person passes away after turning 75, their heirs will need to pay income tax on the inherited pension. However, if the person dies before reaching that age, most lump-sum payments from their pension can be received tax-free, though there is a limit to this exemption.

In a technical report released with Wednesday's Budget, the government projected that 10,500 estates will fall under the inheritance tax category in 2027-28 as a result of the changes to the pension inheritance tax.

The regulation that permits married couples and civil partners to transfer their assets, including pensions, to their partners without incurring taxes upon their death is still active.

Tax professionals mentioned that the limitations on inheritance tax might prompt individuals to transfer their assets to younger family members sooner.

"This adjustment will probably lead to a rise in lifetime gifts, as most people, except those with very small farms and businesses, will rush to sidestep inheritance tax," stated John Barnett, who chairs the technical policy and oversight committee at the Chartered Institute for Taxation.

“This will also lead to an increased workload, as formal appraisals will be required for farms and businesses valued at over £1 million.”

Multiple advisors mentioned that the effects of the tax hikes could be far-reaching.

"The effects on family-run businesses and individuals with substantial pension savings will be significant, and it is still unclear how this will influence the government's ambitious growth goals," stated Simon Allister, the head of wealth planning at LGT Wealth Management.