What rising IHT receipts mean for you

Once considered something reserved for the wealthiest among us, inheritance tax is being paid by more and more estates. But what’s driving this uptick and what does it mean for you? 

Few taxes cause more irritation than inheritance tax (IHT). In a poll last year which asked people to name the tax they hate the most, IHT came out on top.

You may, therefore, find it somewhat puzzling to learn fewer than 4% of deaths result in IHT being paid. What's more, during the financial year 2021 to 2022, total IHT receipts were £6.1 billion, less than 1% of HMRC's total tax take of £716 billion.

So what gives here? Well, it's the direction of travel that's the greatest cause for concern, with both total receipts and the number of estates falling foul to IHT both rising. Let's have a look at what's going on.

What is inheritance tax and how does it work? 

IHT is a tax paid on the estate (property, money and possessions) of people who have recently passed away. There are a handful of instances where you could pay IHT on your estate while you're still alive; more on this further down. 

The standard rate of IHT is steep at 40 per cent, and applies to the portion of individual's estate which exceeds £325,000. However, as we will also explain further down, your tax-free thresold could be higher than this.

The tax on your estate will be paid by the executor of your will, should one be designated, so it’s rare for your direct descendants to be left to pay the estate tax.  

Why are inheritance tax receipts rising? 

While the standard rate of IHT has remained frozen at 40% for some time, as noted above, the amount of money being raised by the tax has increased dramatically in recent years, reaching record highs in the first months of 2022. In May, HMRC took around £1.1 billion through inheritance tax, an increase of more than £100 million on the same month last year. 

The main reason for this is that estate values have risen since the start of the pandemic - from growing transfers of wealth to frantic increases in property values, many more people are tripping into IHT territory, in some cases without realising.  

What is the nil rate band? 

You can think of the nil rate band as a tax allowance. Currently, the nil rate band is set at the aforementioned £325,000, and has remained frozen at this level since 2009. However, between then and today, asset prices – most notably property and shares - have risen sharply. Since the pandemic, UK property prices have posted two consecutive years of double-digit growth, with the average home currently valued at roughly £283,000. 

In April 2017, a second nil rate band was introduced called the ‘residence nil rate band’. This allowance adds a further £175,000 if a person’s primary residence is handed down to, or the sale proceeds are given to children or grandchildren. This means that a married couple could have a combined IHT exemption of £1million (£325,000 + £175,000 x 2). 

What IHT exemptions are available? 

You can mitigate your IHT liability in several ways.

One of these is to leave 10 per cent or more of the ‘net value’ of your will to a charity. In this case, an estate will be taxed a reduced rate of 36 per cent.  

If you own a small businesses, you may be able to use ‘business relief’ which allows some business assets to be handed down free from IHT, or at a reduced rate. This is dependent on certain rules being met. If you're unsure, it's worth seeing an accountant in the first instance. Click on the link below to match with the right one for you.

When it comes to handing your wealth down to your children and grandchildren, one of the best ways to avoid IHT is by gifting, and there are several ways to do this in a tax-friendly way: 

• You are allowed to gift up to £3,000 each year. This is called the annual exemption, and can be given to a single person or split between many. If you haven’t used the previous year’s exemption, you can carry it forward, but only for one year. This means a married couple could gift £12,000 during the current tax year without suffering an IHT charge.
• You are also allowed to gift £5,000 per child, £2,500 per grandchild or great-grandchild, or £1,000 for somebody else if it is given as a wedding or civil partnership gift.  
• You can make as many small gifts of £250 as you like, as long as the individual hasn’t benefitted from another allowance. 

Some financial gifts that aren’t a direct exemption can be classified as potentially exempt transfers. This means that certain gifts will become tax-free if you live for seven years after making the gift.  

It's important to note that if the value of any gift - when added to others during previous seven years - exceeds the nil rate band, it will be classed as an chargeable lifetime transfer, triggering an immediate IHT charge of 20%. 

Finally, if you were to die before the age of 75, any pension benefits held in defined contribution schemes can be passed to younger generations tax free.  

Tips for mitigating your inheritance tax burden 

While it’s up to each person to decide how they want to leave something behind for their children and grandchildren, the right financial planning can help you leave a meaningful legacy for your family. Here are some of our tips for handing your wealth to the next generation, without being hit by a big tax burden: 

1. Prepare a will: it’s important to have an accurate and up-to-date will in case the worst happens, and somebody needs to distribute your assets. Speak to a will writer today and make sure that all your assets are left to those you wish to benefit. 

2. Give your assets away: if you give assets away and survive seven years, these gifts will be free of tax.  

3. Put your assets in a trust: this will mean that they are not considered part of your estate. You can then leave these gifts for your children who could inherit them at the age of 18, for example. 

4. Gift your excess income: if you give an amount of money from your normal expenditure, and it doesn’t reduce your standard of living, these gifts will be free from IHT.

5. Gift assets that are exempt from capital gains tax (CGT): If any assets you own have lost value since you purchased them, they will be exempt from CGT. With the right planning and timing, these can be exempt from IHT if you keep living for seven years. 

By seeking financial advice, you can ensure that your estate is sheltered from the HMRC. Find the right financial adviser today with Unbiased.