Inheritance tax on track for another record year

(Image credit: Pgiam via Getty Images)

published 19 July 2024

The taxman is on track for another record year when it comes to inheritance tax (IHT).

The latest data from HMRC covering April to June shows the government has collected £2.1 billion in inheritance tax since the start of the tax year. This is £83 million higher than the same period a year ago – an increase of more than 4%.

The government collected a record-breaking £7.5 billion in inheritance tax last year, but it looks on track to exceed its previous record, if the current trend continues.

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Frozen nil-rate bands are largely to blame. Frozen thresholds have conspired with high inflation in recent years to leave families at the mercy of fiscal drag.

The current tax-free allowance is £325,000, with an additional £175,000 available to those leaving the family home to their children or grandchildren.

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. It has been held there ever since.

The nil-rate bands won’t be reviewed until 2028.

Will IHT receipts continue to rise?

“As it stands, the government doesn’t have to take any action for IHT receipts to keep rising,” says Jonathan Halberda, specialist financial adviser at Wesleyan Financial Services.

“An already frozen Inheritance Tax threshold [...] combined with rises in the value of assets such as houses, means more people are gradually being pulled into the tax net,” he adds.

When the £175,000 residential nil rate band was fully introduced at the start of the 2020/2021 tax year, the average UK house cost around £230,000. Today, it costs £285,000, according to the latest data from the Office for National Statistics (ONS).

Meanwhile, if you live in a city like London, it’s possible that leaving your home to a relative could use up your entire tax-free allowance, with nothing left to cover the rest of your wealth and assets.

House prices are particularly high in the capital. ONS data shows that the average London house costs £523,000. Combining your regular and residential nil-rate bands would still leave you with a sum of £23,000 that your descendant would have to pay tax on.

While married couples and civil partners can combine their tax-free allowances to pass on an estate worth up to £1 million tax free (£325,000 + £175,000 + £325,000 + £175,000), not everybody is in this position.

What’s more, strict rules on the residential nil-rate band mean you can only use this allowance if you are leaving the family home to a direct descendant. You cannot leave the property to a sibling, niece or nephew, for example.

Many think inheritance tax is only paid by the ultra-wealthy, but this highlights the fact that even ordinary families (particularly those living in expensive cities like London) can find themselves paying a hefty bill.

For this reason, Halberda thinks the tax is “ripe for reform”. He adds that it is “now affecting more people than it was ever originally intended to”.

Will the Labour government change inheritance tax rules?

Labour has been tight-lipped on inheritance tax so far, other than outlining plans in its manifesto to end the use of offshore trusts to shield assets.

However, the new government will need to raise money somehow to fund essential spending, and it has already promised not to hike income tax, National Insurance or VAT.

“Reforms to non-dom rules are one potential source of an inheritance tax windfall, but with an estimated £100 billion being passed on in inheritances and gifts in the UK each year, there’s probably more in play if the government is determined to raise extra cash,” says Nicholas Hyett, investment manager at Wealth Club.

Hyett suggests this could put agricultural and business relief in the firing line, but adds that any reforms would need to be handled sensitively to avoid damaging family-owned businesses and farms.

Labour has also promised a detailed pensions review, so it is possible that this will be another area of focus. Pension pots currently sit outside the inheritance tax net.

However, the government won’t want to do anything that discourages savers from paying money into their pension pots. A key mission for this government is boosting private investment in the UK economy, and pensions are one of the biggest sources of investment capital.

Nothing has been announced so far, so this is all just speculation for now. We should know more once Chancellor Rachel Reeves delivers her first Budget. She has indicated that this could take place as early as September.

Steps to cut your inheritance tax bill

There are some steps families can take to pass their estate on in a more tax-efficient way. Given current projections, “the need for expert financial planning remains crucial,” says Rosie Hooper, chartered financial planner at Quilter Cheviot.

She adds that financial planners can help families manage their estate by “setting up trusts, making use of gift allowances, and using a pension to pass on wealth”.

Under current rules, you can pass your pension on to a beneficiary and no inheritance tax is due. If you die before you turn 75, your beneficiary won’t have to pay any income tax either when they withdraw the cash.

Gift allowances also allow you to give away a total of £3,000 each year without it counting towards your estate. Gifts which exceed this value become known as “potentially-exempt transfers”. If you die within seven years of making the gift, IHT is due on a sliding scale.

Married couples also enjoy inheritance tax perks. They can pass their estate on to their spouse without any immediate tax implications. Furthermore, if one partner doesn’t use up their nil-rate band, they can pass the remainder on to their spouse to use in the future too.

Katie has a background in investment writing and is interested in everything to do with personal finance, politics, and investing. She enjoys translating complex topics into easy-to-understand stories to help people make the most of their money.

Katie believes investing shouldn’t be complicated, and that demystifying it can help normal people improve their lives.

Before joining the MoneyWeek team, Katie worked as an investment writer at Invesco, a global asset management firm. She joined the company as a graduate in 2019. While there, she wrote about the global economy, bond markets, alternative investments and UK equities.

Katie loves writing and studied English at the University of Cambridge. Outside of work, she enjoys going to the theatre, reading novels, travelling and trying new restaurants with friends.