UK Inheritance Tax and New Long Term Non-Residence Rules

The recent UK budget was typical of all government annual fiscal events in that changes to the tax code created winners and losers. It could be argued that more people lost than won, particularly in the realm of Inheritance Tax (IHT).

Major alterations to the taxation of farms saw real tractors, not the Chelsea variety, on the streets of London, with high-profile celebrities leading the slow-moving charge to the Houses of Parliament.

How will UK pensions be Treated?

No one took to the streets about the changes to pension plans, however. All pension scheme holdings will now become liable to IHT if their value exceeds the normal allowance. In extreme circumstances, this could mean an effective tax of 80% for some estates. Even in the case of lower-value estates, a tax charge of 60%+ could apply to pension plans on the plan holder's death.

Whilst I’m not suggesting insurrection, this issue is possibly even more punishing than IHT on farms. It’s vital to be prepared for the new regulations, and a meeting with your financial adviser will be much more effective than waving banners outside the Palace of Westminster. There are solutions to mitigate the effects of the new rules.

Expats and their UK pensions

Expats are rarely considered when the UK government changes the tax system, particularly concerning pension regulations. Most of the time, this is to the detriment of non-UK residents, but occasionally, new opportunities arise that benefit them.

Antiquated ‘Domicile’ rules have always decided UK IHT liability for non-residents. The conditions were unclear, and no one knew whether they were liable or not. This will change in April 2025 when the new residence-based regulations replace the Domicile system.

The 10-year Long Term Non-Resident Rules

Whilst this doesn’t mean that all you have to do is leave the UK to avoid IHT, there are considerable advantages for those who do or are already resident elsewhere as long as they meet the 10-year Long Term Non-Resident rules. So, as soon as someone has been resident outside the UK for 10 full tax years, no liability to UK IHT will apply. Instead, IHT regulations regarding their place of normal residence will determine any tax payable.

The above assumes the individual was previously UK tax resident for at least 20 years. For those who were resident for less than that, different rules apply. The 10-year ‘tail’ can be reduced to as little as 3 years if resident for between 10 and 13 years. Every year above 13 incurs another year of tail.

All is well and good; however, several questions immediately come to mind.

First, will the host country’s IHT regime be more advantageous or less advantageous? IHT rules differ from country to country, so reviewing your situation and checking local rules are important. Double Tax Treaties might help in some circumstances, but the country you reside in will likely determine liability.

In some countries, IHT doesn’t apply, and in others, such as Spain, rates depend on the Autonomous Community in which you are resident. For example, IHT is nil or discounted in Madrid and Andalucia with a 99% allowance.

What happens if someone returns to the UK to be closer to family? The basic answer is that it depends on how long the individual has been non-UK resident and what assets are owned. Assuming a person has been out of the UK for 10 years, they should qualify for the IHT exemption for the following 10 years on assets held outside the UK. Non-UK-based assets can, therefore, be exempt from UK IHT in this period.

Appropriate Financial Planning and Investment Strategies

It therefore makes sense to consider financial planning and investment strategies to ensure that we are taking advantage of non-UK investment plans such as Spanish Compliant Investment Bonds, Portuguese Bonds and French Assurance Vie contracts. These are usually based in Ireland or Luxembourg and would qualify for the additional 10-year exemption. They are all adaptable to UK regulations and can become a useful income generation tool when UK resident as well as whilst abroad.

It is still possible that UK pensions could be liable for UK IHT as they are UK-based assets. By reducing holdings of other UK investments to the bare minimum, the worst of the new IHT regime can be avoided. If a Dual Tax Treaty includes a section on IHT that gives taxing rights to the country of residence, this shouldn’t be a problem. It's best to check, though.

Seek Professional Advice

As ever, the devil is in the details; everyone should review their position with a suitably qualified and experienced financial adviser. For expats, it may be best to consult an EU and UK adviser to ensure they are fully equipped with all information relevant to the country where they are resident and the UK.