Pensions and inheritance tax – what does it mean for clients?
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For professional advisers and paraplanners only. Not to be relied upon by retail clients.
Pensions and inheritance tax – what does it mean for clients?
By Jess Franks, Head of Investment Products, Octopus Investments
The major change is that unused defined contribution pots will be included in the estate for inheritance tax for deaths occurring after 6 April 2027. Much of the detail about how this will work are subject to a consultation.
U
ntil now, keeping capital in your pension was sound planning because it was inheritance tax efficient. It allowed investors to keep access to the capital should they need it, while leaving anything they didn’t spend in their lifetime free from inheritance tax (and in some cases free from income tax).
The Autumn 2024 Budget changed this.
What's changing?
Following the Budget, it’s important to understand what’s changing and what isn’t.
The major change is that unused defined contribution pots will be included in the estate for inheritance tax for deaths occurring after 6 April 2027. Much of the detail about how this will work are subject to a consultation to be launched in the new year.
Most other aspects that relate to the taxation of pensions on death are not changing - if a pension is left to a spouse, it will continue to pass free from inheritance tax.
The income tax treatment of pensions is also not changing. This means 25% of the pot can be withdrawn tax free by the investor during their lifetime, pensions inherited from someone who dies younger than 75 can be drawn down by their beneficiaries free from income tax, and pensions inherited from someone who dies older than 75 will be subject to income tax as drawn at the beneficiary’s marginal rate.
It’s expected pensions will form part of the estate for considering whether the residence nil-rate band (RNRB) can be claimed. This allowance is tapered away for estates worth more than £2 million. More estates are now at risk of losing some or all of this allowance.
For an estate facing these taxes at the maximum rates, the total effective tax rate on the undrawn pot could be above 80%.
The other major change to IHT announced in the Budget concerned Business Relief (BR). BR qualifying investments pass to beneficiaries free from IHT provided they have been held for at least two years when the investor dies. This remains the case for qualifying investments in unquoted companies at up to £1m per individual. BR is an interesting option to consider for clients who previously planned to utilise their pension to pass wealth tax efficiently, because like a pension they enable a client to undertake estate planning while retaining access to that capital should they need it in the future. While these investments cannot guarantee liquidity, they remain in the investor’s name, providing access in usual circumstances should it be needed.
Let’s look at two scenarios where a combination of pension drawdown, investments in Business Relief (BR), and gifts from regular income could return a client to an efficient inheritance position while retaining access to wealth.
SCENARIO 1
Andy is 70. He’s fortunate to have sufficient income from other assets outside of his pension to fund his lifestyle. He had planned never to spend his pension, using it instead to pass £1 million of wealth to his children free from inheritance tax. Following the Budget he wants to revisit these plans.
His adviser recommends that he draws down 25% of his pension, so that he can benefit from receiving this income tax free. He invests the £250,000 withdrawn in unquoted BR-qualifying investments. Once held for two years, his investment will qualify for 100% relief from inheritance tax.
Andy plans to consider making further withdrawals once the final details about the pension tax change have been published. And he may delay any further withdrawals until he reaches 75. Prior to then, his pension will pass with the benefit of income tax efficiency, but after then, the income tax he will suffer will be similar to that incurred by beneficiaries following Andy’s death (note, however, that marginal rates may differ). If this income is used to make regular gifts to beneficiaries, the gifted money will immediately be exempt from inheritance tax. If this reduces the value of his estate to below £2 million, it could also restore the benefit of the RNRB.
The BR-qualifying investments remain in Andy’s name until he dies, providing access to capital should it unexpectedly be needed. Making gifts from funds drawn down can be halted should his circumstances change.
Andy is an investor under 75
SCENARIO 2
Susan is 80 and worried that the change to the inheritance tax treatment of pensions could affect her estate. Even if she dies prior to April 2027, income tax will be payable by her beneficiaries when they draw down her pension, and she’d like to put different plans in place today.
She drew 25% of her pension, tax free, some years ago but has a large pension pot remaining. She meets with her adviser, who makes an assessment based on her needs, objectives and appetite for risk. Susan considers moving to pension drawdown in order to fund her annual expenditure. This will free up £500,000 of investments previously allocated to her living costs, that she could invest in a portfolio of unquoted BR-qualifying shares. Provided she has held them for at least two years when she dies, she should qualify for 100% inheritance tax reliefs.
Susan is an investor over 75
KEY RISKS OF BUSINESS RELIEF-QUALIFYING INVESTMENTS:
A BR investment is likely to be high risk. The value of a BR-qualifying investment, and any income from it, can fall or rise. Investors may not get back the full amount they invest.
BR is assessed by HMRC on a case-by-case basis, and this assessment happens when an estate makes a claim. The ability to claim the relief will depend on the company or companies invested in qualifying for BR at the time the claim is made.
Tax treatment depends on individual circumstances, and tax legislation can change in the future.
Withdrawals cannot be guaranteed, as the shares of unquoted and AIM-listed companies can be harder to sell than shares listed on the main market of the London Stock Exchange. Their share price may also be more volatile.
NEW
THE KNOWLEDGE BASE FROM OCTOPUS INVESTMENTS
Need some support with the technical details of estate planning? Look no further than The Knowledge Base.
We’ve created a comprehensive suite of new technical whitepapers and collated supporting guides, planning scenarios, webinars, calculators and insights, to support advisers and paraplanners on the technicalities of inheritance tax and estate planning.
You can watch the Octopus Investments webinar, Estate planning now and moving forward, where we recap the recent changes to BR and inheritance tax, common misconceptions about BR, and go into detail about some new client planning opportunities following the Budget.
You can find the webinar, new planning scenarios, resources and key budget updates all in one place.
Business Relief-qualifying investments are not suitable for everyone. Any recommendation should be based on a holistic review of your client's financial situation, objectives and needs. This communication does not constitute advice on investments, legal matters, taxation or any other matters. Personal opinions may change and should not be seen as advice or recommendation. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London EC1N 2HT. Registered in England and Wales No. 03942880. Issued January 2025. CAM014669.
THE CLEARER MARKET ENVIRONMENT POST-BREXIT, AS WELL AS A TIGHTER GRIP ON THE PANDEMIC, CREATES AN OUTLOOK CONDUCIVE TO INCREASED LISTINGS ON AIM.
- VAN HOANG, INVESTMENT MANAGER, BLACKFINCH
Smaller stakes have little choice
Unfortunately, individual retail investors are unlikely to hold a large enough stake to change the outcome of these votes. But, on the other hand, in the vast majority of takeovers seen in the first half of 2021, there was a substantial bid premium where the share price increased during the offer period. The highest was an eye-watering 79%, although more commonly, it was in the lower, but still very pleasing 20% - 50% range.
role,
Intelligent Partnership
22
20
6
94
96
3
October 2024 Budget: an update
05
October 2024 Budget: an update
Tom Mullard, Business Line Director, TIME Investments
time-investments.com
020 7391 4747
questions@time-investments.com
In this video, Tom Mullard, Business Line Director of TIME Investments, provides an overview of the key announcements from the Chancellor's first Budget and the potential impact on client’s portfolios.
KEY CHANGES TO BE AWARE OF:
It's always better to buy when the mood is a bit gloomy, as it sends valuations lower and improves future
There has been consistent speculation about changes to both Inheritance Tax and Business Relief with the previous Conservative government and current Labour government.
Following the Budget a number of key areas have changes but there are also areas that have remained untouched.
Overall, the outcome was better than many had feared in the build up to the budget and, whilst Business Relief and Agricultural Property Relief have changed, they should still remain a key part of advisers’ estate planning conversations.
INHERITANCE TAX
Both the Nil-rate band (NRB) and Residence nil-rate band (RNRB) remain frozen for an additionaltwo years until 2029/30.
NIL-RATE BANDS
Unused pension pots will fall into the taxable estate and be subject to Inheritance Tax from April 2027. This potentially opens up a number of planning opportunities with clients.
PENSIONS
A number of key changes were announced that will take effect from April 2026:
BUSINESS RELIEF (BR)AND AGRICULTURAL PROPERTY RELIEF (APR)
1)
2) 3)
A new combined £1 million allowance per individual will apply to the combined value of 100%BR & APR assets
Assets over the £1 million allowance will only receive BR and APR at 50%
AIM shares and other listed shares not on recognised exchanges will be subject to a flat 50% rate of BR but will not contribute to the £1 million allowance
This is our understanding from the current information available and we expect the Government to release more information in due course.
Important information
TIME Investments is the trading name of Alpha Real Property Investment Advisers LLP, with its registered office at 338 Euston Road, London NW1 3BG. TIME Investments is authorised and regulated by the Financial Conduct Authority, under FCA number 534723.
The information contained in this article does not constitute and should not be construed as constituting investment or tax advice by TIME Investments. Any views or opinions expressed are solely those of the author and do not necessarily represent those of TIME Investments. The levels and bases of, and reliefs from, taxation may change in the future. Any favourable tax treatment, such as Business Relief, is subject to government legislation and as such may change. Investors’ capital is at risk.
THE CLEARER MARKET ENVIRONMENT POST-BREXIT, AS WELL AS A TIGHTER GRIP ON THE PANDEMIC, CREATES AN OUTLOOK CONDUCIVE TO INCREASED LISTINGS ON AIM.
- VAN HOANG, INVESTMENT MANAGER, BLACKFINCH
Smaller stakes have little choice
Unfortunately, individual retail investors are unlikely to hold a large enough stake to change the outcome of these votes. But, on the other hand, in the vast majority of takeovers seen in the first half of 2021, there was a substantial bid premium where the share price increased during the offer period. The highest was an eye-watering 79%, although more commonly, it was in the lower, but still very pleasing 20% - 50% range.
role,
Intelligent Partnership
22
20
6
94
96
3
Business Relief Sector Spotlight: The Resilience of Purpose Built Student Accommodation in the UK
04
Business Relief Sector Spotlight:
The Resilience of Purpose Built Student Accommodation
By Zenzic Capital
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ost COVID, purpose-built student accommodation (PBSA) has emerged as one of the most resilient and attractive* sub-asset classes within the UK real estate market. This has prompted many investment professionals and market commentators to look closer at the sector and scrutinise what is driving investor appetite. Here, we summarise the key drivers, as well as the inherent opportunities and challenges for investors.
For many, their children's education is a high priority expenditure (perhaps second only to shelter). Accordingly, the demand for it is relatively inelastic and endures even during economic downturns and cost of living challenges.
*as measured by capital inflows
THE FUNDAMENTALS
Long-term secured rental, real estate value is driven by the quality, security and longevity of its cash flow. The demand for student accommodation has remained strong despite COVID and cost of living challenges, driven by several demographic and structural tailwinds:
1
GROWING STUDENT POPULATION
The number of 18-30 year olds is growing globally and with it the number of students in the UK continues to rise, with a record 2.4m full time students registered in 2022/2023. International students are a key component of this demand (c.30%) with faster growing populations and an expanding middle-class seeking to access UK tertiary education.
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RESILIENT INCOME STREAMS
Purpose Built Student Accomodation assets offer a nuanced cash flow with several appealing characteristics. The first is its resilience. For many, a child’s education is a high priority expenditure (perhaps second only to shelter). Accordingly, the demand for it is relatively inelastic and performs strongly even during economic downturns and/or cost of living challenges. Secondly, PBSA income offersan attractive hybrid of short- and medium-term cash flow features, which lowers risk through diversification. On a short-term basis, student rents are repriced annually (which brings the ability to pass on inflation costs via rent uplift). This compares favourably to other real estate asset classes where rents are revisited typically not before 5 years. Normally the downside of these shorter-term tenancies is income insecurity, as tenants are locked in for a shorter time period and re-letting risk occurs more frequently. But with PBSA, students typically require accommodation for 3 years minimum and possibly longer if post-graduate study is undertaken. Thus the hybrid of short and medium term cashflows: the benefit of yearly upward repricing with the security of mid-term length
3
UNIVERSITY EXPANSION AND ACCOMMODATION SHORTAGE
Many UK universities lack sufficient accommodation facilities for their growing student populations. Using the latest student data from HESA, the ratio of full-time students to beds is 2.7 across the 20 largest student cities. Five cities have a ratio of over 3.0 (a market norm is often quoted at 1.5). Additionally, many students who may previously have utilised HMO properties are now seeking bespoke accommodation where student requirements are actively catered to. The movement away from HMO towards PBSA should increase the demand-supply
4
UK LEADERSHIP IN TERTIARY EDUCATION
The UK is the leader in European, if not global, tertiary education. 14 of its institutions were listed in the top 50 Institutions in the recent Times Higher Education report, with 6 in the top 10. The brand power of these institutions creates long-term, inelastic
5
THE GREAT ROTATION
Institutional allocations to office and retail have more than halved over the last 12 years, from 55% to 26%. What’s filling the gap? To a large extent: industrial and living sectors (which includes PBSA). Why does this matter? Well, this $200B to $300B pot of capital has the lowest cost of equity in the industry and largely defines benchmark pricing. If demand for PBSA increases from institutional buyers, pricing and investor returns should improve.
THE OPPORTUNITIES
For investors who want exposure to PBSA, the question is how to access it? We see a number of opportunities in this regard.
BUILDING THE NEXT GENERATION PORTFOLIOS
AFFORDABLE PBSA
DIVERSIFICATION
If demand persists or increases, the shortfall in supply will only be remedied through increasing PBSA stock. Opportunity exists to create new, curated portfolios via bespoke developments that combine the amenity provision that students increasingly demand with the safety and environmental features investors value.
Affordable PBSA is fast becoming the El Dorado of the sector. As rents increase, there is the danger that a cross section of the student population is priced out. Increasingly, PBSA owner operators are looking to provide accommodation at more affordable price points while generating sufficient income to cover the costly development spend to build the assets. There are numerous initiatives underway in this regard and while outside the compass of this article, we believe that an affordable PBSA offering - properly structured - can deliver compelling returns for investors, while at the same time expanding access to accommodation for those who need it.
For investors seeking diversification, PBSA is an attractive option. It offers exposure to a distinct asset class within the property market, and one that is protected from the fluctuations of the broader residential or commercial property sectors. Investing with investment managers who understand and have access to the sector is a straight forward means of achieving this.
In January 2024, Zenzic Capital launched a new UK-focused purpose-built student accommodation (PBSA) strategy targeting a portfolio gross development value (GDV) of over £500 million to address the acute shortage of high-quality PBSA in the country. The initiative includes investing in existing stock and developing new assets. The strategy began with a joint venture (JV) with Torsion Group, working on projects that will deliver 1,566 rooms by the end of 2025, focusing on popular Russell Group university cities with sustainability and ESG principles at their core. Two schemes, already operational and fully let, are located in Leeds and Nottingham, while three others, under construction, will be ready by the 2025/26 academic year.
CHALLENGES IN FINANCING AND INVESTING IN PBSA
RISING CONSTRUCTION COSTS
One of the primary challenges in developing PBSA is the rising cost of construction materials and labour. Inflationary pressures, compounded by supply chain disruptions have increased the costs associated with building new developments. Developers may face difficulties in maintaining project viability if construction costs continue to rise, potentially eroding profitability margins.
MARKET SATURATION IN CERTAIN AREAS
While demand for PBSA remains strong in many cities, there is a risk of oversupply in some regions. Developers and investors must conduct thorough market research to ensure that their projects are located in areas with sustainable demand. Overbuilding in certain locations could lead to increased vacancy rates and downward pressure on rental prices, ultimately impacting returns.
MACROECONOMIC AND POLITICAL RISKS
While the PBSA sector has shown resilience in the face of economic challenges, broader macroeconomic factors such as inflation, interest rate hikes, and political uncertainties could affect financing costs and investor sentiment. Furthermore, changes in immigration policies or the international appeal of UK universities could impact the number of international students, which would, in turn, affect the demand for PBSA.
Conclusion
The UK’s purpose-built student accommodation sector remains a compelling investment opportunity, driven by strong demand from students and attractive yields. Investors can benefit from high occupancy rates, stable income streams, and competitive financing options. However, challenges such as rising construction costs, planning hurdles, and market saturation must be carefully managed to ensure long-term success. Despite these challenges, the PBSA market is expected to remain a robust and attractive asset class for investors looking to diversify their portfolios and capitalise on the ongoing growth of the UK higher education sector.
Book a call if you’d like to hear more about the Zenzic Estate Planning Service or visit our website: zenziceps.com
