The rules and regulations around inheritance tax (IHT) can be fiendishly confusing, complex and, if you’re not careful, costly.
And while there are rumours Rishi Sunak is looking at cutting or reforming IHT, this levy will likely remain an issue for taxpayers for years to come.
IHT wins no prizes for being the UK’s least favourite tax, according to a 2019 Hargreaves Lansdown survey, owing to the idea that it saps away at people’s hard-earned wealth after they have passed, regardless of how much they may be leaving behind.
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The tax is levied at a rate of 40% on estates worth more than £325,000. On top of this, the government introduced the “main residence nil-rate band” in 2017, exempting all or part of the value of the family home from IHT provided the beneficiary is a child or grandchild.
So, there are ways to lower your IHT tax bill and having a better understanding of the nuances of the levy, as well as who pays it could help you avoid some potential pitfalls.
Here are six common IHT myths, debunked by experts, to help save you money.
It raises a large amount of money for the government
Despite it being one of the most contentious taxes, the overall sum of money generated from IHT for the Treasury is relatively small in comparison to other tax levies.
Last year, IHT raised just £6.4bn - less than both tobacco duty (£9bn) and alcohol duty (£12bn).
Niki Patel, tax & trust specialist at St.James’s Place says: “In more recent years, there has been an increase in IHT receipts however, even with this being the case, in comparison to other taxes, for example, income tax, national insurance, capital gains tax, corporation tax and VAT, IHT does not currently raise significant amounts for the government.”
The reason for the general increase in receipts, according to Patel, is fiscal drag. The IHT tax threshold (or nil rate band) has been held at £325,000 since the 2009/2010 tax year, while asset prices, notably house prices have continued to rise. This has dragged more and more people into the IHT net.
Only the very wealthy pay inheritance tax
Around 3.76% of deaths in the 2019 / 2020 tax year resulted in an IHT charge, but, as Alex Hunt, legal director in Birketts’ private client advisory team notes, some of us may end up in the 3.76% without knowing it.
“The average house price in the UK in January 2022 was just under £300,000, although for some areas this figure is significantly higher. IHT can therefore apply to those who are merely well-off rather than very wealthy,” Hunt explains.
In areas like London, which have seen significant house price appreciation over the past three decades, the risk of having to pay IHT is even greater. “Due to the rate at which property values have increased over the past few decades, many people who purchased their homes 30 years ago could now find that their assets exceed the IHT allowances,” explains Hunt.
A property can be gifted, meaning no tax will be payable on it
For most people, their house is the biggest asset they own, which means it’s likely if any IHT is due, it’ll be on the value of their main residence.
While there are certain reliefs available for those passing on their main residence, it’s not always possible to pass on a home without having to pay IHT.
One way to get around this issue is to pass on a home before it’s too late.
In practice, a property can be gifted to someone tax-free, according to James Ward, head of private clients at law firm Kingsley Napley.
“However, if the person gifting dies within seven years of making the gift the value of the gift will be added into their IHT calculation,” he says.
In addition, if the person gifting continues to derive a benefit from the property then the value of the property will be subject to IHT at the date-of-death value.
“Other taxes may apply to a gift of property, for instance, stamp duty land tax and capital gains tax, so professional advice is important,” he adds.
To complicate matters, a property can be transferred between spouses or civil partners, but IHT will still be payable on the property on the death of the second partner.
Take a look at our article on how to reduce your IHT bill by gifting.
IHT only applies to property
There is a preconception that IHT only applies to property, and while a house may make up a significant portion of the total tax liability, almost every asset within an estate is liable.
Birkett’s Hunt says; “IHT applies to almost every asset with the available exemptions being very limited. By way of two examples of how niche most of the outright exemptions are, medals awarded for “valour or gallant conduct” are outside of the scope of IHT, as are war savings certificates.”
He explains there are a number of reliefs that can apply to other classes of assets, such as business and agricultural assets.
“These can be extremely valuable in reducing exposure to IHT. However, the conditions are strict and should be checked carefully if they are to be relied upon,” he says
Assets abroad are not counted for UK IHT
If you live in the UK and are domiciled here your entire estate worldwide is potentially taxable on your death regardless of where it is situated.
Nigel May, tax partner at Gravita says this includes holiday homes, foreign investments, and foreign bank accounts.
“The fact that there is a liability to death duties in another country does not mean that you have no liability to UK tax, although normally there is a ‘pecking order’ between countries. For example, if there is a liability to tax in Spain on a holiday home situated there, you will be given credit for the Spanish tax paid, so that you don’t pay tax twice. The rules are different for individuals not domiciled in the UK,” he adds.
Everyone will pay some form of IHT
One of the biggest myths around IHT is that everyone will pay some form of the levy. But as we covered above, only a small percentage of estates have to pay.
That being said, most estates will have to prove to HMRC there’s no IHT to pay before the distribution of assets can begin.
Still, when it comes to paying the tax, “the reality is that barely anyone pays it,” says Andrew Oury, partner at accountancy and legal firm Oury Clark.
And the rate of tax paid is actually lower among larger estates than it is among smaller ones. HMRC data shows estates worth £10m or more paid an average of 10% in tax in 2015-16 - half the average 20% tax paid by estates worth £2m to £3m. “The very wealthy avoid it as does much of the rest of the world,” adds Oury.
With that in mind, we’ve pulled together four strategies you can use to try and lower your IHT liability.
How to lower your inheritance tax bill
- Make full use of any allowances
The current IHT system allows up to £175,000 of the family home to be passed on tax-free, which is effectively doubled to £350,000 when combined with the allowance of a spouse or civil partner. On top of this, the £325,000 standard nil-rate band is available, meaning it is possible to pass on £1m IHT free as a couple.
Shaun Moore, tax and financial planning expert at Quilter says the band only works for those “with direct descendants to inherit the family home” and is capped at the value of the property being inherited – less any outstanding mortgage.
It’s also possible to pass on money tax-free via pensions.
- Gift wisely
Gifting is one of the most common ways people avoid IHT bills, owing to the number of concessions and freebies available.
Moore says: “Gifts to spouses or civil partners are completely free of IHT and each tax year up you can gift up to £3,000 with your annual exemption, so as a couple this could be a combined £6,000 a year. In addition, there is no limit on excess income – above normal expenditure – that can be gifted.”
- Consider a transfer
Large gifts, including property, are classed as Potentially Exempt Transfers (PETs) or Chargeable Lifetime Transfers (CLTs), and their value will not be counted as part of the estate upon death, assuming the person who makes the gift lives for a further seven years.
Moore says such transfers can be “particularly useful for estates of more than £2m” which are impacted by the RNRB taper as the gifts can immediately reclaim the extra band.
One of the ways the very wealthy reduce their IHT liabilities is to invest in different types of assets, such as shares listed on AIM, farmland and private businesses. Investments under the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) can also be IHT-free. However, this is quite a complex area, and these investments may be unsuitable for most.
Tom is a journalist and writer with an interest in sustainability, economic policy and pensions, looking into how personal finances can be used to make a positive impact.
He graduated from Goldsmiths, University of London, with a BA in journalism before moving to a financial content agency.
His work has appeared in titles Investment Week and Money Marketing, as well as social media copy for Reuters and Bloomberg in addition to corporate content for financial giants including Mercer, State Street Global Advisors and the PLSA. He has also written for the Financial Times Group.
When not working out of the Future’s Cardiff office, Tom can be found exploring the hills and coasts of South Wales but is sometimes east of the border supporting Bristol Rovers.
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