The government could be looking to raise more money from death duties by changing inheritance tax (IHT) rules in the upcoming Budget, according to reports.
It comes as chancellor Rachel Reeves looks for ways to tackle a £22bn overspend from the previous government, and a £40bn funding gap going forwards.
The Treasury does not comment on speculation outside of fiscal events and has not confirmed the reports. However, Reeves is expected to go after inheritance tax exemptions rather than increasing the rate at which the tax is charged. At 40%, the standard inheritance tax rate is already high compared to other duties like capital gains tax.
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Sources briefed on Reeves’s Budget preparations told the Financial Times she has looked at extending the seven year rule on gifting to 10 years. But there are a range of other areas she could consider too.
There is also an expectation that Reeves could target business and agricultural property relief and AIM shares. Pension pots could also be in focus, as they are excluded from the inheritance tax net under current rules.
Alternatively, the government may look at applying capital gains tax on inherited assets at the point they are passed down to a loved one. This could effectively result in a “double death tax” of more than 50%, according to accountancy firm RSM.
Chris Etherington, private client partner at the firm, says this route could “prove tempting to the chancellor”, especially as the rules are complex and “unlikely to be as well understood as a simple change in tax rates”. This means it could be a “safer political path to tread”.
Any changes are likely to be unpopular. IHT receipts have already been hitting record highs in recent years, soaring to £7.5bn in 2023/24.
One in 20 people say losing inheritance tax exemptions is their biggest fear in the Budget, according to a recent Opinium survey commissioned by Hargreaves Lansdown. This rises to one in 10 among retired people.
Will Labour change the rules on inheritance tax?
Inheritance tax is a very divisive and politicised tax and policy expectations have yo-yoed in recent times. Just a year ago, many were expecting former Conservative chancellor Jeremy Hunt to scrap the tax in his 2023 Autumn Statement. Ultimately, this did not materialise.
Prime minister Keir Starmer has been clear that the Autumn Budget will be “painful” and involve “tough decisions”, prompting commentators to warn the public of widescale tax hikes. But Starmer and Reeves have already ruled out increases to income tax, employee National Insurance contributions and VAT – and this leaves them with little wiggle room.
Inheritance tax could seem like an easier tax to target given the broad misconception it only impacts the ultra-wealthy.
“Rachel Reeves is not short of encouragement from think tanks, a couple of which are keen that IHT ‘loopholes’ should be closed, or that wealthy families should be prevented from making the most of certain reliefs,” says Ian Dyall, head of estate planning at wealth management firm Evelyn Partners.
“The Institute for Fiscal Studies and Resolution Foundation have both weighed in with recommendations to restrict Business and Agricultural Property Reliefs, and to bring defined contribution pension pots into the calculation of estates for IHT purposes,” he adds.
Meanwhile, if Reeves decides to go after gifting allowances, she could consider cutting the annual gifting limits or changing the rules around ‘potentially-exempt transfers’ to restrict the amount of wealth families can pass on tax-free before death.
How much can you pass on without paying inheritance tax?
Under current rules, you can pass on an estate worth up to £325,000 before an inheritance tax bill is due, with an additional £175,000 allowance for those leaving the family home to their children or grandchildren. These allowances are known as the regular and residential nil-rate bands.
The £325,000 allowance has been at this level since 2009, while the £175,000 residential nil-rate band was phased in between 2017 and 2020. House prices have risen considerably in this period, meaning families are now able to pass on less wealth before being hit by a hefty tax bill.
The average UK house price was around £230,000 when the residential nil-rate band was first introduced, according to data from the Office for National Statistics (ONS). Today it is £293,000. Meanwhile in London, the average house now costs £531,000.
The good news is there are some strategies you can take to pass on more of your estate tax-free. For example, married couples and civil partners can combine their tax-free allowances to pass on an estate worth up to £1 million (£325,000 + £175,000 + £325,000 + £175,000).
This rule leaves out single parents or unmarried couples looking to leave a property to their offspring, though. Furthermore, only direct descendants are able to take advantage of the residential nil-rate band – so siblings, nieces and nephews are excluded.
Does inheritance tax only impact the wealthy?
Only around 4% of estates pay inheritance tax under current rules, but fiscal drag is drawing more families into the inheritance tax net. MoneyWeek analysis shows that inheriting an average-priced house from a single parent in London could leave you with an inheritance tax bill of more than £12,000.
As this reveals, rising asset prices mean it's not just the ultra-wealthy who are impacted. In fact, they often pay less inheritance tax than those who sit somewhere in the middle.
“The super-rich tend to avoid it by hiring tax advisers to navigate the complex web of reliefs and exemptions,” says Rachael Griffin, tax and financial planning expert at Quilter.
“Consequently, the majority of the annual £7bn revenue comes from those who are well-off, but largely because they have worked hard, saved, and invested diligently throughout their lives,” she adds.
Against this backdrop, it’s unsurprising that IHT is one of the most-hated taxes in Britain – and it could be about to get a whole lot more unpopular.
