Having a Good Understanding of the Opportunities and Threats Will Help You Make the Most Out of the UK Tax Regime
After weeks of speculation about possible changes to National Insurance, Capital Gains Tax, Inheritance Tax, ISAs, pensions and, of course, what constitutes a “working person”, we now know what was actually announced.
Let’s look at the key personal financial planning aspects.
We’ll start with the proposed change to the way pension funds will be treated on death as this will affect many of our clients.
PENSIONS - TREATMENT ON DEATH
The government wants to remove the incentive to use pensions as a tax planning vehicle for wealth transfer after death. Therefore, pension funds will be subject to Inheritance Tax (IHT) from 2027.
At present, pensions do not generally form part of someone’s estate and are exempt from IHT.
Furthermore, if the pension scheme member dies before age 75, currently their beneficiaries are able to draw money from the inherited fund free from income tax. Where the pension scheme member dies after age 75, their beneficiaries pay income tax on any withdrawals from the inherited fund but it is still currently free from IHT.
Because of the IHT efficiency of pensions, many people currently spend other assets, such as ISAs and bank savings, first and then use their pension funds later in retirement. This approach may need to change.
The government has published a consultation on the policy so it will be interesting to see how this develops.
Unmarried couples
The initial suggestion is that there will be a spousal/civil partner exemption (as there already is with IHT), meaning that the IHT charge will apply on “second death”. Unmarried couples may therefore decide to get married/become civil partners so as to better protect each other financially.
Potential for 67% tax
What is not entirely clear is whether the inherited fund will also suffer income tax, leading to double-taxation and a possible 67% tax charge.
By way of an example, if a £100,000 fund that was subject to IHT was inherited by a 45% income tax payer, the fund would drop to £60,000 after 40% IHT and then to just £33,000 after 45% income tax. We’ll see how this is dealt with in the consultation.
PENSIONS - ALLOWANCES
Annual Allowance
No new changes were announced to the Annual Allowance (what you can pay in tax-efficiently). This remains at £60,000 p.a.
As is already the case, this is reduced for very high earners, down to a minimum of £10,000, under the Tapered Annual Allowance rules.
Lifetime Allowance
There was also no suggestion in the Budget that the Lifetime Allowance (how much you were allowed to build up in your pension tax-efficiently before suffering tax on the surplus) would be reinstated. This was abolished in April 2024.
25% Tax free lump sum allowance
There had been much talk in the press about a possible reduction in the Lump Sum Allowance. This is currently capped at £268,275. In the end, no changes were announced to this.
Despite the proposed changes to death benefits, pensions continue to be a very generous investment vehicle given that not only can you receive a generous tax break on money that you pay in, but you can also benefit from very tax-efficient returns on a year-by-year basis.
ISAs
The ISA allowances will remain unchanged at £20,000 for adult ISAs, £9,000 for Junior ISAs and £4,000 for Lifetime ISAs. These allowances will now be frozen until April 2030.
Any growth or income that builds up within your ISA portfolio continues to be extremely tax efficient.
INHERITANCE TAX
The inheritance tax nil rate band stays at £325,000, with a further £175,000 for the residence nil rate band (RNRB). These allowances were previously frozen until 2028 but this has now been extended to 2030.
It is worth noting that under current rules the RNRB is up to £175,000 per person but is lost at a rate of £1 for every £2 of taxable assets above the Taper Threshold of £2,000,000.
It will be interesting to see whether the proposed 2027 pension IHT changes will mean that pension values start to count towards this £2,000,000 figure. If they do, many people with a large house and large pension fund will face of double whammy of their pension funds becoming subject to IHT and, at the same time, losing up to £175,000 of their tax-free IHT allowance.
A worked example
Let’s imagine a couple with a £1 million house, £1 million of pension funds and £1 million of other assets. They have adult children who will inherit their estate.
Currently, their position on second death might look like this:
Total estate £2 million
IHT allowances £1 million (NRB plus RNRB)
Taxable estate £1 million
IHT bill £400,000 (IHT rate is 40%)
If we fast-forward to April 2027, their position might look like this:
Total estate £3 million
IHT allowances £650,000 (NRB but no RNRB)
Taxable estate £2,350,000
IHT bill £940,000.
INCOME TAX AND NATIONAL INSURANCE
Most of the impact of the Budget falls on employers in the form of increased employer NI payments.
For individuals, income tax thresholds, which have been frozen since 2022, are due to start to rise in line with inflation from 2028/29 onwards.
At present, the first £12,570 of income is covered by the Personal Allowance (unless your income is over £100,000 at which point you start to lose it).
Basic rate tax (20%) is payable on income between £12,570 and £50,270 at which point higher rate tax (40%) begins. Finally, income above £125,140 is hit by additional rate tax (45%).
The dividend allowance dropped from £2,000 in 2022/23 to £1,000 in 2023/24 and then to just £500 in 2024/25. It will remain at this level. The dividend tax rates for basic rate, higher rate and additional rate taxpayers will remain at 8.75%, 33.75% and 39.35% respectively.
STATE PENSION
The state pension will rise by 4.1% in April 2025, with the Chancellor announcing a commitment to the ‘triple lock.’
This means that the full new state pension will increase to £11,975 p.a. and the full, old basic state pension will increase to £9,175 p.a.
PRIVATE SCHOOL FEES
As previously announced, a 20% VAT rate will apply to private school fees from January 2025.
The Treasury said that it expects fees to go up by about 10% on average as a result of this change.
CAPITAL GAINS TAX
The CGT allowance dropped from £12,300 in 2022/23 to £6,000 in 2023/24 and then to just £3,000 in 2024/25. The allowance will stay at this low level.
There had been rumours of a significant rise to the CGT rate, but this hasn’t materialised.
Instead, from 30th October, the CGT tax rate has increased from 10% to 18% for basic rate taxpayers and from 20% to 24% for higher and additional rate taxpayers. This brings the tax rates in line with the higher rates that already apply for the sale of a residential property (which isn’t your main residence).
IBUSINESS ASSET DISPOSAL RELIEF
Of particular relevance to our business owner clients, there had been much speculation about changes to “Entrepreneurs relief”, to use its previous name.
The lifetime limit for business asset disposal relief remains at £1m. The tax rate will remain at 10% for the remainder of 2024/25 and will rise to 14% in April 2025 and then again to 18% from 2026/27.
STAMP DUTY
The Stamp Duty surcharge payable on a purchase of a second home or investment property is rising from 3% to 5% from 31st October 2024.
This is 5% on top of the standard rates of Stamp Duty. This is yet another measure that makes owning a second home or investment property less attractive.
A FINAL WORD
The understandable challenge for many households is working out how best to fund their present, not their future.
But if you are already in the positive position of having built up savings, pensions and investments or have the means to be able to do so going forward, generous opportunities exist within the UK’s personal finance landscape.
If you would like impartial help thinking through what you can do to plan your own financial future, please call us on 020 3488 9505.
The value of your investments can go down as well as up, so you could get back less
than you invested.
Tax and Estate planning is not regulated by the Financial Conduct Authority.