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Only the richest four per cent of families pay inheritance tax, but many fear being drawn into its net, especially if there is an attack on wealth in the Budget.
Although the vast majority of estates are unaffected, it is still regularly described as Britain’s most hated tax.
And the Government is collecting ever-larger sums because frozen inheritance tax thresholds and soaring property prices mean the estates of more bereaved people are becoming vulnerable.
Inheritance tax: only four percent of the richest families pay it, but many are worried about being caught in its net
The latest HMRC figures show that from April to August this year, estates have paid out £3.5bn, which is £300m more than over the same period in 2023.
Although 4.4 per cent of estates paid inheritance tax in 2021/22 (or 28,000 out of a total of 634,000), revenues soared to a record £6bn.
How can you find out if your family will have to pay inheritance tax under the current rules and how will you be affected by the changes the Government is introducing in the budget on 30 October? Here’s how to do it.
How much is IHT and who pays it?
Inheritance tax is levied at 40 percent on assets above two key thresholds when people die.
To calculate the size of an estate, you need to add up the value of all your property (minus mortgages), investments, savings, and other assets.
For your loved ones to have to pay inheritance tax, you need to have an estate of £325,000 if you are single or £650,000 if you are jointly married or in a civil partnership. zero rate band.
But there is an additional £175,000 individual allowance if your estate is higher than this and you leave your own home to your direct descendants. This is the Zero rate residential band.
Increases the maximum threshold to £1 million jointly if you have a partner and own your home.
Once your estate reaches £2m, this ‘own home’ allowance starts to be phased out at a rate of £1 for every £2 above that threshold, and disappears completely once you exceed £2.3m.
This is Money tax columnist Heather Rogers explains: ‘Many people are allowed to leave a further £175,000 in assets without having to pay inheritance tax if their home forms part of their estate and they leave it to their direct descendants.
‘That means children, including those adopted, stepchildren or foster children, and the direct descendants of those children.
‘This additional sum is what is called the residence nil rate band, and is available to claim in the event of death from 6 April 2017.
‘Both protected amounts or “bands”, which total £500,000 per person, can be transferred to a surviving spouse or civil partner if they are not used when the first spouse dies.’
Heather Rogers has responded to many readers on inheritance tax issues (see below).
“Inheritance tax casts a long shadow,” says Sarah Coles, personal finance director at Hargreaves Lansdown.
‘Millions of people are worried about the impact this tax could have on their families. Rumours about possible changes to the October Budget have further fuelled anxiety about inheritance tax.
‘Even those who are well below the current thresholds are concerned that adjustments to this tax could mean HMRC keeps a large chunk of their estate after their death.’
What could happen to IHT in the Budget?
Increase the inheritance tax rate from 40 percent
Coles says: “Less than one in 20 farms pay for it, so it wouldn’t make a huge amount of money. If the rich are hit hard, they will pay for expert help to reduce their bill, so it could limit profits even further.”
Zero rate band change
Zero-rate residency tax bands exclude childless individuals who leave their estate elsewhere, usually to other family members such as siblings or nieces and nephews.
If the government wants to stop penalising childless people, it could make the residence tax-free band available to them too, or scrap it and increase the tax-free band to £500,000 for everyone.
But it could scrap it and set the threshold at £325,000 for everyone, or set it at some new level between that and £500,000.
Imposition of inheritance tax on pensions
Beneficiaries do not pay tax on inherited defined contribution pension funds up to the limit of the deceased’s lifetime allowance, if the holder dies before age 75, or their normal income tax rate if they are age 75 or older.
The last government also considered taxing withdrawals from pensions inherited by younger savers with an income tax, but ultimately abandoned the idea.
Coles says a change would not affect people who use their pension to buy an annuity, or have defined benefit pensions, or who plan to spend their pension over their lifetime.
Do you have any questions about taxes?
Heather Rogers, founder and owner of Aston Accountancy, is This is Money’s tax columnist.
She answers your questions on any tax topic: tax codes, inheritance tax, income tax, capital gains tax and much more.
Check your previous columns to see if you have already resolved your tax problem.
Or you can write to Heather at taxquestions@thisismoney.co.uk.
‘It will hit hardest those with larger estates who do not spend their pensions, either because they die earlier than expected or because they have used their pension to help reduce their inheritance tax bill.’
> What could happen to pensions in the Budget?
Rules for spouses and married couples
“Anything you leave to your spouse or civil partner is free of inheritance tax, and if you pass everything to them after your death, it also passes through your zero-rate bands,” says Coles.
‘This means that when the second person in a married couple dies, they can leave assets worth up to £1 million tax-free.’
Modification of the exemption of agricultural and commercial property
These benefits primarily benefit the very wealthy, and you should consult a financial advisor before using them to mitigate inheritance tax.
The Government could decide to tighten rules in these areas, but will want to avoid harming family farm owners and small family businesses.
Discouraging entrepreneurship or funding start-ups would also conflict with its mission of promoting economic growth.
How to beat the inheritance tax
Sarah Coles of Hargreaves Lansdown looks at some of the options.
– If you are concerned that the Government may cut the zero rate band, you can donate up to £3,000 before the change, which will be included in your annual giving allowance.
– You can gift larger sums and they will be taken out of your estate after seven years. There is a separate rule which means you can also gift excess income free of inheritance tax.
– If you have children in your life who are under 18, you could consider paying £3,000 into a Junior ISA for them each year.
You can pay up to £9,000 into Junior ISAs each year, but some of this amount would only disappear from your estate after seven years.
– If you are investing in qualified AIM companies and plan to take advantage of the inheritance tax exemption, this is not necessarily a signal to sell.
If the government were to remove the tax break entirely, it would mean introducing retrospective taxation and could seriously harm investment in smaller, publicly listed companies.
This means you may want to consider alternatives, such as changing the qualifying period. If the investment is suitable for your portfolio, there is no point in rushing into a decision to sell.
– If you are concerned about the tax treatment of capital gains on death, it is a good idea to take capital gains each year if you can and transfer as many assets as possible into a stocks and shares (ISA) during your lifetime, using the process of swapping shares (Bed & Share ISA).
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