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Last year, the total amount of inheritance tax paid stood at £8.3 billion a year but, by 2030/31, it’s expected to balloon to £14.5 billion, according to Budget documents.
That means that even though inheritance tax wasn’t significantly increased in the Budget – as many feared – more families are likely to be affected. Find out what’s happening and how you can prepare.
What’s on this page?
There were no big changes for inheritance tax in this year’s Budget. The only significant news for most people was an extension to the freeze on nil rate bands for a further year, to 2031.
This includes the standard £325,000 nil rate band and the £175,000 residence nil rate band which can be claimed if you are passing a family home to direct descendants. But while feared restrictions on the amounts that can be gifted IHT-free didn’t materialise, the Budget documents revealed a huge increase in predicted IHT receipts.
And it’s not just individual tax bills that are set to rise. More families can also expect to face a bill when loved ones die. This year the number of taxable estates is expected to be 32,200, which is 9,000 fewer than previously predicted, and equivalent to about 1 in 20 estates.
That will rise to 63,100 by 2030/31, which is about one in 11 estates, according to the Office for Budget Responsibility.
James Scott-Hopkins, founder of wealth management firm EXE Capital Management, says: “We know that the number of families being dragged into the inheritance tax net will [almost] double by 2031, with the OBR forecasting that by the start of the next decade, 9.3% of all deaths will be subject to IHT.”
Rising IHT bills have largely been the result of frozen thresholds and rising asset prices, including family homes. Scott-Hopkins says: “Receipts are already at record highs because of decades of house price rises and the insidious freezing of the NRB threshold, which has been stuck at £325,000 since 2009. In that time, the consumer prices index (CPI) has risen by approximately 60%, the average house price by 73%, and the average portfolio (made up of equities and bonds) by 139%.”
Although the nil rate band has been the same since 2009, the additional threshold (the residence nil rate band) was introduced in 2017 at a rate of £100,000, and increased each year until it rose to its current rate of £175,000 in 2020. But since then, the number of estates being affected and the amounts being paid have been rising steadily.
The amounts paid are expected to rise even faster in the coming year as upcoming changes (announced in last year’s Budget) come into effect.
Madeleine Beresford, partner at TWM Solicitors, says: “In addition to the fiscal drag we’ll see from the extended freeze to the nil rate band, over the next six to 18 months we will also start to see the impact of last year’s changes in terms of the restrictions on agricultural and business property relief, and also the pensions being brought into the IHT net.” From 2027, unused defined contribution pension pots will be treated as part of the estate for IHT purposes.
Beresford adds: “The pensions point is hugely significant, not only because of the tax on the pension itself, but the fact it takes many people over the £2m threshold for the residence nil rate band.” RNRB is withdrawn at a rate of £1 for every £2 over £2m, which means that some estates going over that level could face an effective tax rate of up to 87%.
Rob Morgan, chief investment analyst at Charles Stanley, adds: “Once a tax reserved only for the nation’s wealthiest families, IHT has now planted its flag firmly in Middle Britain thanks largely to a potent mix of house price growth, frozen thresholds, and soon the inclusion of pension pots in the calculations.”
If your estate is likely to be subject to IHT when you die, there are ways to reduce the tax bill, or potentially avoid one altogether.
If you have a partner that you’re not married to or in a civil partnership with, that could be one option, since transfers between spouses are free of inheritance tax, with no limits.
Apart from that, Morgan says that the easiest way to slim down an estate is normally to start gifting wealth to your children or other loved ones.
“Presently, gifts made from ‘surplus income’ can be made free from IHT, which can at least help prevent an estate becoming larger and incurring more tax. But for this to apply the administrators of your estate must be able to demonstrate that the gifts formed part of normal expenditure, were made from income and left the donor with sufficient income to maintain their usual standard of living.”
He adds: “There are also some smaller gifting allowances that can help at the margin. Exempt gifts include an annual £3,000, which can be given to one person or spread between several people, plus £250 a year to as many people as you like. In addition, you can make one-off marriage gifts of up to £5,000 to children and £2,500 to grandchildren.”
These allowances are per person, meaning married couples can gift double the listed amounts between them.
Gifts beyond these allowances are known as potentially exempt transfers. This means that you need to live for a further seven years after making the gift for it to become wholly tax-free. Taper relief may reduce the tax rate payable after three years, but only if the total value of your gifts exceed the nil rate band.
For those with more complex family arrangements, or where you might want more control over who gets what and when, it may be worth considering a trust.
Sue Allen, chartered financial planner at Chester Rose Financial Planning, says that remembering a favourite charity when you die can be a savvy way to pay less tax. “Leaving a charitable legacy in your will, such as giving 10% or more of your chargeable estate, can reduce your IHT rate to 36% [from 40%].”
Some people might also want to consider a life insurance policy (written in trust) to cover a future IHT bill.
Before you start gifting, there’s a lot to consider. Rachael Griffin, tax and financial planning expert at Quilter, says: “While gifting can be a powerful tool when it comes to reducing any eventual IHT bill, it is important you don’t leave yourself short-changed in life.”
Morgan agrees: “Making large gifts will leave you without the money in future should you need it for whatever purpose, be it ticking things off your bucket list, unexpected emergencies, or any costs involved in later life care. It’s great to help your family out and see them enjoy the money, but if in doubt, always think about the airline cabin crew advice of ensuring you fit your own life vest before helping others.”
He adds: “The rules around inheritance tax are complicated and the administration can be fiddly, so if in any doubt, make sure you consult a regulated financial planner to ensure you are not making any mistakes that will unnecessarily increase your estate’s tax burden.”
Getting legal or estate planning advice can be useful to help you calculate your potential tax bill and put in place a plan that will cut your tax bill effectively, without jeopardising your future financial security.
Provided by HUB Financial Solutions Limited
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