The amount paid by Britons in inheritance tax (IHT) last year hit a record level, according to data released on Tuesday.
Between April 2023 and March 2024 some £7.5bn was paid in IHT, which is £0.4bn higher than the same period last year, figures unveiled by HM Revenue and Customs (HMRC) showed.
The numbers are partly down to the fact that the Government has frozen the threshold at which the tax starts being payable until 2028, preventing it from rising with inflation and forcing extra families to pay.
Alastair Black, head of savings policy at abrdn, said: “This month marks 15 years since the IHT nil rate band was last increased. This freeze, combined with rising asset values, means that the tax is affecting more and more people than it was ever intended to capture. This needs to be fixed if IHT is to go back to its original purpose.”
There were rumours that the tax would be scrapped – or reduced – last year in the Autumn Statement, but these did not come to fruition.
Below we run through how the tax works, and how you can limit the amount you’re paying.
Who pays inheritance tax?
IHT is paid on the estate of someone who has passed away, with funds from the estate used to pay HMRC. This is done by the person dealing with the estate.
Crucially, there’s normally no tax to pay as long as the value of the estate is below £325,000, or everything over this threshold that’s left to a spouse, civil partner, a charity or a community amateur sports club.
If you give away your home, or “main residence” to your children – including adopted, foster or stepchildren or grandchildren – your threshold can increase to £500,000.
On top of this, if you’re married or in a civil partnership and your estate is worth less than your threshold, the unused threshold can be added to your partner’s threshold when you die, meaning they can end up having a threshold of up to £1m.
How much is inheritance tax?
The standard inheritance tax rate is 40 per cent and this is charged on the part of your estate that’s above the threshold.
This means that if your threshold is £325,000 and your estate is worth £400,000, you only pay 40 per cent on £75,000.
The estate can pay at a reduced rate of 36 per cent on some assets if it leaves 10 per cent or more of the “net value” to charity.
There are additional rules too. For example, the £175,000 extra allowance for your home only applies if the estate is worth less than £2m. On estates worth more than this, the allowance will decrease by £1 for every £2 above £2m that the estate is worth.
And there are also additional exemptions. For example, no tax is due on any gifts you give if you live for seven years after giving them – unless the gift is part of a trust.
You can also give away a total of £3,000 worth of gifts each tax year without them being added to the value of your estate, even if you do pass away within seven years.
What do experts say should happen to inheritance tax?
Many experts claim that inheritance tax needs to be simplified.
Mr Black said one way to achieve this would be to remove the residence nil rate band and increase the standard nil rate band.
“This would create a more streamlined regime, and encourage more people to engage with estate planning – helping wealth move more freely between the generations, which in turn could bring significant benefits to the economy and those under financial pressure amid the ongoing cost of living crisis. It would also no longer penalise those without children, and who aren’t marred or in a civil partnership, creating a more equal tax system.”
Rachael Griffin, tax and financial planning expert at Quilter, said that some would hope for a lowering of the rate from 40 per cent.
She said: “The lowering of the headline rate would undoubtedly be met with approval from core Tory voters. However, more widely, it would likely prove unpopular given it would benefit the rich at a time when so many across the nation continue to struggle with the cost of living.”
She added: “A more equitable and simplified IHT system involving raising the nil rate band to £500,000 would not only be fairer but more reflective of the changing demographics and societal structures of this country.”
How to cut your inheritance tax bill
There is a full list of rules and exemptions in our guide on how to avoid the tax trap.
But below are a few things it is worth bearing in mind if you want to cut your bill.
The seven-year rule
Any gift is tax-free if you live for at least seven years after giving it. If you die within seven years, the gift counts as part of your estate and tax will be due on a sliding scale.
Each tax year, you also get a gift allowance of £3,000. This can be to one person or spread across several people. This allowance can be carried forward one year if you don’t use up all your allowance, and in addition, you are able to make small gifts of up to £250 per person per year, with no limit on the number of recipients. (As long as you have not used another allowance on the same person.)
Another option is to “gift from income”. You can give someone regular gifts from surplus income, providing it does not hinder your own standard of living, and the money will be tax-free (it won’t form part of your estate). Make sure you keep a record of this for the taxman.
Pensions
Most defined contribution pensions – the most common type of pension in the private sector, where you build up a pot of money – are free from inheritance tax.
If you die before the age of 75, your beneficiaries could get the money entirely tax-free. If you die after the age of 75, your family will pay income tax on the money.
Since the lifetime allowance was effectively abolished in April, you can save as much as you want into your pension pot without incurring a tax charge (although your 25 per cent tax-free cash is capped at £268,275), meaning your pension could be a good inheritance tax shelter for any extra cash.
Mortgages
Older homeowners are increasingly using mortgages to minimise their inheritance bill.
You can take out a mortgage on a property you own outright, then gift the money raised from the mortgage to your children, and, as long as you do not pass away within the next seven years, the gift is tax-free.
Mark Incledon, chief executive at Bowmore Financial Planning, said that taking out a mortgage and gifting this money “can be an effective part of inheritance tax planning”.
A growing number of banks and building societies are willing to lend to the over-sixties, but if you can’t get a regular mortgage you could consider equity release.
Equity release is a type of mortgage, but instead of paying the loan back monthly, the interest “rolls up” and you pay it back when you die or move into care. If you take out the loan and gift the money, the money will be taken out of your estate so you will not pay inheritance tax on it (providing you live for seven years).
Beware that equity release can turn into an expensive loan. The interest “rolls up”, so you pay interest on your interest. If you took out an equity release loan of £50,000 at 6.99 per cent and the house was sold 10 years later, you would owe more like £100,000.
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