Is an inheritance tax (IHT) cut on the way?

Inheritance tax (IHT) could be cut or eradicated in next week's Autumn Statement amid improved public finances. 

According to reports in The Telegraph, Rishi Sunak and Jeremy Hunt have drawn up plans to reduce the so-called death tax.

Treasury officials have concluded the move would not be inflationary, meaning it passes a critical test that the chancellor has set for tax cuts this autumn. It was confirmed yesterday that Sunak has delivered his promise to halve inflation this year, after CPI inflation hit 4.6% in the 12 months to October.

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Cutting IHT would be good news for wealthy families, and could help push up the government’s public ratings ahead of next year’s general election.

Other reforms expected to be announced in the Autumn Statement, on 22 November, include changes to ISAs, and possibly a statement on the state pension triple lock.

Laura Suter, head of personal finance at the investment platform AJ Bell, comments: “It wouldn’t be a fiscal update without numerous rumours and leaks in the week ahead – and this year’s Autumn Statement is no different. Fresh off the back of clinching its inflation reduction target, it appears thoughts have immediately turned to how the government could cut taxes next week."

According to economists at JP Morgan, the chancellor has enough room to cut taxes by as much as £10 billion.

Suter says it's unclear if IHT will be reduced, and if so what sort of rate cut it would be, "but any headline rate cut would benefit larger estates enormously".

Cutting the rate from 40% to 35% would save an estate worth £1.5 million a total of £25,000 in tax, in comparison to the £467,500 it would save an estate worth £10 million, says Suter. A much larger cut to 20% would net an estate worth £1.5 million a tax saving of £100,000, but a tax saving of £1.87 million for estates worth £10 million.

It is perhaps surprising the government is considering tinkering with IHT, given it is such a moneymaker for them. 

Data from the OECD (Organisation for Economic Co-operation and Development) shows that the UK has one of the highest IHT exemption thresholds in the world. We are also highly unusual in that we tax the estate of the deceased. Most other countries tax the recipient of the inheritance. 

In the last financial year, a record £7.1bn was collected. That is £1bn more inheritance tax than the year before. The soaring value of assets, combined with a threshold that has been frozen since 2009, means the taxman makes more every year. 

Hunt has a couple of options such as changing the IHT thresholds or lowering the tax rate that an estate pays.

Here is how IHT could be reformed and the difference it could make.

 OPTIONS FOR IHT REFORM 

Currently, once someone passes away, IHT is charged on the value of their estate above the nil-rate band allowance of £325,000.

The levy is controversial as in many cases it will be money that someone has already paid tax on, plus it reduces the inheritance that can be left for loved ones.

There is also an allowance for your main home -  the residence nil-rate band - worth £175,000 and assets can be passed tax-free between spouses so in theory a married couple or people in a civil partnership can eventually pass on a combined £1m to their children before IHT is due.

The residential nil-rate band isn’t helpful if you don’t own your own home though and the property can only be passed to direct descendants such as children, grandchildren or great-grandchildren.

The standard IHT rate is 40% but this can be reduced to 36% if you leave 10% or more of the net value of your estate to charity in your will.

Analysis by wealth manager Quilter suggests that raising the IHT threshold to £500,000 and removing the residence nil-rate band would prevent around 12,500 families from paying inheritance tax each year. 

Further calculations show that if the Treasury instead reduced the rate of IHT from 40% to 30%, around 27,000 estates would pay IHT, but their bills would be reduced.

“Making moves to modernise inheritance tax could be a real rabbit out of the hat moment for Hunt at the Autumn Statement," says Shaun Moore, tax and financial planning expert at Quilter.

“Despite IHT being paid by only 4% of the nation, it is a tax that many people find egregious. Therefore, any changes could help garner the Conservatives some much-needed popularity ahead of next year’s general election.”

Moore says increasing the IHT threshold and scrapping the residential allowance would remove complexity from the system while not costing the government a huge amount over the long term. 

“Reducing the headline rate of tax would help reduce bills, which would no doubt be popular, but it could be costly for the government and people will still get landed with an IHT bill,” he adds.

“If any changes are announced any benefit could be short-lived as if Labour does form the next government it has already stated that it would reduce some of the IHT reliefs available such as Business Property Relief and Agricultural Property Relief.”

Ways to reduce your inheritance tax

Rather than waiting for tax changes, there are steps you can take to reduce your IHT bill and ensure there is more of an inheritance for your loved ones. 

1. Make sure you understand the thresholds
After you die your estate is valued. If all your worldly goods including property, investments, savings and personal possessions add up to more than £325,000, you may be liable for IHT. This means 40% of anything above that nil-rate band may need to be handed over to the government. 

• Everyone can pass on up to £325,000 to loved ones without any IHT being due.
• On top of that, if you pass your primary residence on to your children or grandchildren, up to £175,000 of that is free from IHT. In other words, each of us has the potential to pass on £500,000 tax-free.
• Anyone who is married or in a civil partnership can inherit their partner’s entire estate without having to worry about IHT. Then, when they die, they can use both partners’ allowances. So, married couples can potentially have an estate worth £1m and not be liable for IHT.

2. You can give away money and assets before you die to avoid IHT
You can give away whatever you like in your lifetime and, provided you live for seven years afterwards, it won’t count as part of your estate for inheritance tax purposes. 

If you do die within seven years, then the gift will be counted as part of your estate and if IHT is due, it will be charged on a sliding scale depending on how long ago the gift was made. If you die three years later, for instance, the tax due on the item falls from 40% to 32%. 

You can also give a variety of financial gifts each year that are immediately exempt from IHT. This includes:

• A £3,000 annual gift allowance, which can be split among numerous people or given to one. You can carry this allowance over for one year if any of it is unused. 
• You can also make as many small gifts of up to £250 per person as you like – provided it doesn’t go to someone who has already benefited from your £3,000 gift allowance that year. 
• If someone you know is getting married or entering a civil partnership, you can give them an additional gift. This is £5,000 if they are your child, £2,500 for a grandchild or great-grandchild and £1,000 for anyone else. 
• Finally, there is the gifts-from-income rule.

This last one is the one most people aren’t aware of. You can pass on as much money as you like so long as it comes from your income rather than existing assets. There are four rules to remember:

• The money has to come from income, not capital. 
• It has to follow a regular pattern – for example, monthly or annually. 
• Giving the money away can’t affect your everyday standard of living. 
• You must record your intention to make the gift regularly. This can simply be a letter that you both keep a copy of.