The Treasury is edging closer to a record year for inheritance tax (IHT) receipts after estates paid £5.7 billion in the nine months between April and December 2023.
The tax intake is £400million more than the same period of 2022 and analysts expect a record breaking year for the tax due to frozen IHT thresholds meaning more estates face paying the controversial tax charge due to high house prices and rising values of other assets.
It comes amid rumours of IHT reforms either in the spring budget or the Tory general election manifesto.
Start your trial of MoneyWeek today
Get unparalleled financial insight, analysis and expert opinion you can profit from.
Start your trial
Sign up for MoneyWeek’s free twice-daily newsletter.
Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.
“Inheritance tax may only be paid by 4% of estates but this hasn’t stopped our IHT bill surging to an estimated £5.7bn for the year so far,” says Helen Morrissey, head of retirement analysis at Hargreaves Lansdown.
Latest Videos FromMoneyWeek
“It looks increasingly likely that we will see another record-breaking year with IHT set to top last year’s £7.1bn by tax year end.”
One in every 25 estates pay inheritance tax, according to Wealth Club analysis, which suggests the average bill could increase to £239,000 this 2023/2024 tax year, with more than 30,000 families having to hand over part of their inheritance to the taxman.
It is a 11.5% increase from the £214,000 average paid just three years ago and a 14.4% rise in the number of estates paying the tax.
“Contrary to popular belief, inheritance tax doesn’t just affect the super-rich. Frozen tax brackets mean many who would not consider themselves wealthy will find themselves falling into the IHT bracket in future, says Nicholas Hyett, investment manager at Wealth Club.
“Their standard of living hasn’t changed, indeed inflation means it might have gone backwards, but the government now considers them to be wealthy enough to face inheritance tax.
“Even at its current level, IHT affects more families than it appears at first glance. While only 4% of deaths result in an IHT charge, a lot of that is because there is no IHT due when estates are passed on to a spouse. It’s on the death of the spouse that an IHT bill falls due. That suggests the number of families affected is more like 7% or 8%.”
There were rumours that IHT thresholds or the tax rate would be cut at the previous Autumn Statement but these failed to materialise.
“Reported government plans to axe inheritance tax at the last Autumn Statement were widely criticised, but with a mixture of frozen thresholds and historic house price growth pulling more people into the net, we may well see plans to reform this tax made a feature of March’s Budget,” adds Morrissey.
“Increasing thresholds and gifting allowances that haven’t been touched for years could help some families from falling into the net and would likely prove more popular than a decision to scrap it completely. For the sake of simplification, it also makes sense to do away with the separate nil rate band for property and roll it all into one.”
Shaun Moore, tax and financial planning expert at Quilter suggests it may prove hard for the government to go so far given that IHT impacts a relatively small pool of people but brings a reasonable amount of tax revenue.
“Abolition of IHT would certainly split voters and it’s likely that Labour would fairly rapidly vow to bring it back into force if they were to get in,” he says.
“This could therefore become a serious area of contention over the following few months if the Conservative party is minded to push ahead with abolition. Regardless of which political party gets into government, simplification of IHT is certainly overdue.”
How to reduce your IHT bill
You don’t have to wait for government reforms though and there are steps you can take to reduce your IHT bill.
This includes using the £3,000 annual exemption, or gifts made out of surplus income.
“However, you must take care to document your gifting carefully so there is a full record of what you have done,” adds Morrissey.
Money left to your spouse or civil partner is automatically tax-free, so make sure this is reflected in your will.
Pensions can be passed on to the next generation relatively tax efficiently, and the nil-rate residential band will help many pass on properties without too much hassle, adds Hyett.
He warns that while tax efficient, ISAs are not IHT-free.
An alternative is to invest in an AIM ISA, a managed portfolio of AIM shares that can be IHT free after two years.
“You still get the ISA benefits of tax-free income and growth for as long as you live, but you don’t need to worry about IHT on top,” he says.
“For those who don’t expect to need their savings in the near term, and who are prepared to take more risk, investing in early-stage businesses through Enterprise Investment Schemes or Seed Enterprise Investment Schemes might be worth considering.
"Not only are they very tax efficient, including being free of IHT after two years, but your money goes to fund entrepreneurial companies, which is great for economic growth and job creation.”
