How investors are responding to inheritance tax changes

As of next year, pensions won’t automatically escape the clutches of the taxman when there is a death.

For years, inherited pensions did not form part of an estate for inheritance tax (IHT) purposes – but that will change from April 2027 after a decision by Chancellor Rachel Reeves at her first Budget back in 2024.

From then on, retirement savings will be included when the tax bill for those inheriting money is calculated.

It means those approaching retirement with large amounts of assets and savings have to rethink their plans if they want to avoid their families being hit with a bill.

Generally, those hit by IHT are wealthier than average. The 40 per cent tax only applies to estates worth over £325,000 and there are multiple extra allowances that mean for many people it is far bigger.

You get an extra £175,000 allowance if passing on a primary home, and spouses’ pool allowances, meaning many couples can pass on £1m tax-free.

Some are starting to think about ways to shield their cash, and there is one scheme experts say many of the wealthiest are looking at more.

The enterprise investment scheme – and how it works

The Enterprise Investment Scheme (EIS) is a UK Government initiative designed to help smaller companies raise money by offering a range of generous tax reliefs to individual investors who purchase new shares in them.

There are various rules regarding the types of companies that can be involved; for example, they must have fewer than 250 full-time equivalent employees and gross assets of less than £30m at the time the shares are issued.

The tax benefits of investing are plentiful.

Investors can claim 30 per cent income tax relief – so a £20,000 investment will attract a £6,000 income tax reduction, and any gains made are not subject to capital gains tax (CGT).

Crucially, for planning your estate, EIS shares can qualify for relief from IHT. To qualify, the EIS shares must be in companies that meet business relief requirements and must be held for at least two years at the time of death.

Business relief for IHT is capped at £2.5m – shares worth less than this can face zero IHT – with any excess above this threshold taxed at a reduced rate of 20 per cent rather than 40 per cent.

Are more people using the scheme?

“There is understandable expectation that demand for EIS could increase as more estates become subject to inheritance tax,” explains Jason Hollands, managing director at Evelyn Partners. Hollands says he is already seeing “growing interest” in the scheme.

Moray Wright, CEO at Parkwalk Advisors, which manages several EIS funds, says the organisation is seeing an increasing number of savers using their pension lump sum to invest in companies via its funds.

“For the right investors, it’s becoming a key strategy in their financial planning, especially as other tax wrappers tighten,” he says.

But experts warn it’s still relatively niche, because of the risks involved.

Hollands explains: “We’ve long used EIS as part of inheritance tax planning for certain clients, but it’s important to remember that these are not mainstream investments.

He says the companies involved are “inherently higher-risk” because they are new and growing at pace.

What sort of companies can you invest in?

If you invest using EIS, you generally invest in a fund which includes multiple companies, so that your cash is spread and diversified.

Parkwalk Advisors says its investors put in a minimum of £25,000 to join its funds and the money is locked away for four to eight years.

Example firms that have been invested in, in the past, include Opsydia – a company developing laser technology able to write intricate features on diamonds and glass – and Accelercomm, a firm that designs hardware that improves the performance of 5G internet.

Who does it suit?

Financial planners are keen to stress that the EIS is generally an option for those who can afford to absorb losses.

“It’s principally aimed at wealthy, sophisticated investors who can tolerate the risks involved, or for individuals who have received professional financial advice and understand both the opportunities and the potential for capital loss,” explains Hollands.

Megan Rimmer, a chartered financial planner at Quilter Cheviot, says the same.

“I tend to see EIS used by clients who have already built a strong foundation with more conventional investments and are looking to allocate a portion of their wealth to higher-risk, tax-efficient opportunities,” she explains.

For other investors, Rimmer says pensions and ISAs “remain the more appropriate starting point given their simplicity, flexibility and more predictable outcomes.”

Other ways to cut IHT bills

For those for whom EIS is not an appropriate scheme, there are other ways to cut your family’s potential IHT bill.

Matthew Beck, chartered financial planner at Smith & Pinching, gives his top tips below:

Use your annual gift exemption: Every individual can gift up to £3,000 per year completely free of IHT. This annual exemption sounds modest, but a couple gifting consistently over many years can move meaningful sums out of their estate to whoever they choose.

Potentially Exempt Transfers (PETs): Any gift you make to someone becomes exempt from IHT if you survive seven years from the date of the gift. Known as Potentially Exempt Transfers, or PETs, these are a powerful and simple way to reduce your estate’s tax liability. There is no upper limit on the amount you can give, but remember the seven-year clock only starts the moment the gift is made – so acting sooner rather than later matters. If you survive less than seven years, a tapered rate is applied.

Discounted Gift Trusts: These are a useful halfway house that works a bit like a PET, but allow you to receive an income stream from your gift. If you place a lump sum into a trust, you can continue to receive a regular, fixed income from it even if you no longer control it. After seven years, any portion of the trust you don’t have access to will be deemed outside your estate. While you should seek expert advice before setting up a trust, they can be very helpful if you want to reduce your IHT exposure but can’t afford to give capital away entirely.

Whole of life insurance: A whole of life insurance policy, written in trust, will pay out a lump sum when you die that sits outside your estate and can be used by your beneficiaries to pay an IHT bill. It won’t reduce the tax itself, but it will ensure your loved ones have the funds they need to pay it, without having to sell off property or other assets they inherit.

To find out more about how EIS works, visit our EIS Knowledge Hub.