Inheritance tax on pensions could destroy thousands of family businesses

Times

a day ago

Thousands of family firms face being wiped out by a little-understood tweak to inheritance tax rules, experts say.
The move by the chancellor, Rachel Reeves, to charge death tax on pensions could force the liquidation of businesses, jeopardising jobs and the broader economy, according to the wealth manager Evelyn Partners. It said that about 15,000 businesses are at risk.
From April 2027 unspent pension assets will be subject to inheritance tax and, crucially, pension schemes will have to settle their share of the tax bill within six months of the pension holder's death.
This shift, which was revealed in the autumn budget, will hit business owners who have held commercial property — such as company premises, workshops or machinery — within their self-invested personal pensions (Sipps) or small self-administered schemes.
What's the problem?
Holding company assets within pensions has been widely recommended for years, allowing business owners to draw rental income from their property in retirement. These pension assets can then be left to beneficiaries tax-free, passing on the operational reins of the company to the next generation and ensuring the continuity of the family enterprise.
However, this once-sensible succession planning is now poised to become a fiscal nightmare.
Gary Smith from Evelyn Partners said: 'It could be a serious problem for thousands of small and medium-sized businesses that are flying under the radar, probably because it's not widely understood.
'Together with the host of tax and cost pressures on entrepreneurs and family businesses at the moment, owners and directors who don't take advice or make preparations could fall foul of the new inheritance tax charge — with the end result in some cases that their businesses are liquidated and jobs lost.'
It's about liquidity
The most immediate danger that the inheritance tax changes could pose stems from the illiquid nature of commercial property. Selling a building or piece of machinery that is held within a pension could take months or years, unlike cash or shares which can be sold or moved instantly. Under the government's proposals, a pension scheme (not the wider estate where other cash may be available) would have to settle an inheritance tax bill within HM Revenue & Customs' six-month deadline.
'On the death of the business owner, the firm could face the prospect of a disruptive fire sale of their premises to meet a tax bill that could even jeopardise the survival of the firm,' Smith said.
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Failure to meet the deadline would trigger interest charges and penalties from HMRC, adding to the the financial strain on grieving families and vulnerable businesses.
What are the rules?
The inheritance tax rules allow you to pass on £325,000 of your estate inheritance tax-free. You can get an extra £175,000 allowance if your estate is worth less than £2 million and you leave your main home to direct descendants, such as children or grandchildren. This gives you a potential £500,000 tax-free allowance. Anything left to a spouse or civil partner is tax-free and they can also inherit one another's unused allowances, allowing a couple to pass on up to £1 million tax-free. Anything above these thresholds can be subject to 40 per cent tax.
Any unused part of a pension, including property, is also exempt from inheritance tax — until April 2027. After that date, companies will face big tax bills and could find their ways to pay limited, given the immovable nature of commercial property. One option would be a fire sale of illiquid assets — potentially taking financial hits because of the need to settle up quickly.
Another option would be for the pension holder to build up cash reserves in their fund to mitigate tax bills after their death. This could, however, inflate the value of the pension and, therefore, the potential inheritance tax bill.
Double blow
Another change is in the pipeline that will also make it harder to pass on a family firm. Business relief tax exemption, which at the moment gives qualifying business interests 100 per cent exemption from inheritance tax, will be cut in April so that only the first £1 million of such assets will get full relief. Any value above that will get 50 per cent relief.
A £5 million family business would be fully exempt from inheritance tax under today's rules, but from April, £4 million of that value would get partial relief, leaving £2 million exposed to a 40 per cent tax rate.
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Smith said: 'The pending inheritance tax on pensions rule change is just one more blow to entrepreneurs and small and medium-sized businesses, coming alongside the new cap on business relief, higher capital gains tax, employer national insurance hikes, a big jump in the minimum wage and the new employee rights legislation.
'It's not just about the impact on business owners' retirement plans but about the threat to jobs and investment and the harm this will cause to entrepreneurship.'
'This will drive a bus through my life's work'
One businessman based in the north of England started up a small self-administered pension scheme in 1993. His logistics company was growing, he was looking to buy up nearby land, and his adviser recommended putting it into a pension.
'They said, look, you are a growing business, why don't you set up a pension fund and start making contributions and then you can get to a point where you can buy the land next door in a tax-efficient way,' explained the company boss, 66, who now gets a pension from the scheme.
He bought the first property through the fund in 2000, and it expanded to hold five worth a total of about £20 million. They include the main two facilities that his logistics company operates in, which pay rent back to the fund, and three rented by other businesses.
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Buying property through a pension fund has several tax advantages: no tax is paid on rental income paid to the fund by tenants of the properties it holds and they are also free from capital gains tax if sold.
It also meant that the boss's two children, who are trustees and beneficiaries of the fund, could inherit the fund tax-free.
But then came the change to inheritance tax rules, which means that if he and his wife die after April 2027, their children would have to find £9 million within six months to settle the tax bill.
With most of the fund tied up in property, this could mean the children having to quickly sell the business premises.
'It'll have to be a fire sale, meaning we probably won't get good value on the sale, and selling these facilities will damage the family business, potentially irreparably,' he said. 'Rachel Reeves is driving a bus right through my life's work with these changes.'