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Nearly £6bn of Inheritance Tax (IHT) was collected in the 2021/22 tax year according to the latest Government figures – a new record for British families.
While these figures are from a couple of years ago – it can take time for the official numbers to be fully collated – it shows a trend towards more estates being liable for the tax, and the numbers are set to keep rising.
With the Office for Budget Responsibility predicting the IHT take will grow to £9.7bn by 2028/29, it's important to understand why an increasing number of people are falling into the IHT net, and whether there’s anything you can do to reduce the chance of your own estate being liable.
The latest figures show a steady increase in the amount of IHT paid – up by £230m (4%) on the previous year – but also a rise in the number of families needing to pay the tax.
In total there were 27,800 IHT-paying estates in 2021/22 – 800 more than the previous year – and experts aren’t surprised by these increases.
“As assets like property and investments rise in value, more estates pass over the thresholds of the £325,000 nil-rate band and the £175,000 residence nil-rate band,” says Ian Dyall, Head of Estate Planning at Evelyn Partners.
The nil-rate band is the amount you can pass on when you die without having to pay IHT. It currently stands at £325,000 – and has been frozen until 2028 at the earliest.
If you're giving on your home to children or grandchildren, you can usually pass on a further £175,000 tax free, using the additional residence nil-rate band. This would take your total allowance to £500,000.
At the time of writing, married couples and civil partners can leave an estate of any value to their surviving spouse or partner without any IHT charges.
They can also leave them any unused percentage of the nil rate bands, meaning a couple could potentially leave up to £1m to their children free of IHT.
Although only 4.39% of UK deaths in 2021/22 resulted in an IHT charge – fewer than one in 20 – some demographics were hit harder than others.
Looking at the ‘average effective tax rate’ (the amount paid as a percentage of the total estate, rather than the 40% headline charge on IHT) estates worth between £3m and £4m paid the highest rate at 25%.
As well as being almost double the average – 13% – this is also higher than on more valuable estates.
A few factors fuel this spike as Liz Colfer, Chartered Financial Planner at Five Wealth, explains: “These estates will have lost the residence nil-rate band due to the taper.”
(The taper here refers to how the residence nil-rate band reduces for estates over £2 million – it gradually drops by £1 for every £2 that the estate is worth over £2 million, until it’s completely eradicated when the value hits £2.35m – even if the property is left to children or grandchildren.)
“Additionally, [these are] less likely than larger estates to hold business or agricultural assets, which attract IHT relief. It means that effective IHT planning is particularly important to these medium-sized estates,” adds Colfer.
If you’re thinking your family may have to deal with an IHT bill, it can be a good idea to speak to an independent adviser to make sure you’ve got a good grasp of the options available, as it can be complicated.
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The latest HMRC figures also highlight how wealth is moving through families and who ends up generating the IHT bill.
Couples taking advantage of the spouse and civil partner exemption is the largest used in 2021/22, with £15.5bn passing this way.
HMRC’s figures also show that female-owned estates have higher IHT liabilities than those owned by men – £3.07bn compared to £2.93bn.
As women live longer on average, this may be a result of them inheriting everything from their partner, which then creates an IHT liability on their estate.
Colfer says this underlines the importance of everyone being involved with IHT planning: “It’s great that you can leave everything to your spouse or civil partner IHT-free, but make sure you both have the confidence to make estate planning decisions if you’re left on your own.”
Charities saw an increase in the amount of money left to them in wills in 2021/22, with donations increasing to £2.1bn – up from £1.8bn in 2020/21.
This uptick may be a symptom of heightened compassion during the pandemic, but Shaun Moore, Tax and Financial Planning Specialist at Quilter, believes it’s also about growing awareness of the tax relief.
"Charities and will writing companies are promoting the tax relief more,” he says.
Anything you leave to charity will be taken off the value of your estate before IHT is calculated. If you leave at least 10% of your estate to a good cause (or multiple causes), your IHT rate may qualify to be cut from 40% to 36%.
Although most families won’t have an IHT bill to worry about in the future, it’s still important to consider if there’s anything you can do to reduce a future IHT liability.
“Planning is key, so if you choose to do nothing, you are more likely to end up paying it,” says Moore.
Giving gifts during your lifetime, rather than leaving it all in your will, can help to cut a future IHT liability – although, again, it’s worth speaking to a professional for help around your specific situation when it comes to giving away money.
Everyone has an annual allowance of £3,000, which can be made up of gifts to one person or a few people. Additionally, you can give as many gifts as you want of up to £250, per person, every year, providing you haven’t used another allowance for them.
However, it’s important to make sure you’ve got enough to live on, long-term, before providing for others. You might think that giving everything away before you die is a sensible option, but if you then need money for care or other emergencies, it can leave you in a rather tricky spot.
Weddings also bring an additional IHT gift allowance, with the amount dependent on your relationship to either of the couple getting married or forming a civil partnership. Each tax year you can give £5,000 to children, £2,500 to grandchildren and £1,000 to anyone else, before their wedding.
There’s also an exemption for any regular gifts from your income (not from savings or other capital) after paying your usual living costs – such as repeated contributions to school fees or putting money into a family member’s savings account.
“As long as these gifts don’t impact your standard of living, this exemption is unlimited,” explains Sarah Coles, Head of Personal Finance at Hargreaves Lansdown.
“Do make sure you keep thorough records so you can prove these are gifts from income.”
If you want to give more than the exemptions allow, your gift is known as a ‘potentially exempt transfer’ (PET).
If you live for at least seven years after making the gift, it will usually be outside your estate for IHT purposes. If you die before, your estate could be liable for tax on these gifts on a sliding scale, potentially reducing based on the number of years you live after giving the gift.
Another way to reduce a future IHT bill is to simply spend your money. Although this won’t suit everyone (especially if you want to leave as much as possible to your family) it can be a great option if you’ve already provided for your loved ones and you're still faced with leaving a significant IHT bill.
Colfer explains: “After putting other estate planning strategies in place, I’ve sent some of my clients home to write a bucket list. Whether it’s holidays, a new car or a favourite hobby, spending can be a fun and effective way to reduce an IHT liability.”
You should consider your pension when deciding how to share your money. Although its primary objective is to fund your retirement, Moore says it can (at the time of writing), be a useful IHT planning tool.
“You can [usually] pass your pension pot on free of IHT,” he explains. “If you’re in retirement, you might want to consider turning the pension tap off and taking your income from other sources, such as ISAs or savings, that would count towards your estate for IHT purposes.”
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