Inheritance tax (IHT) is a significant consideration for individuals planning their estate in the UK. The guide will help you understand what IHT is, why it exists, and how it impacts both estates and beneficiaries. It will also provide insights into recent changes and strategies for effective planning.
What is inheritance tax?
Inheritance tax is tax applied to the estate of a deceased person. This typically includes their property, savings, investments, and possessions. It is only levied if the value of the estate exceeds a certain threshold, known as the Nil-Rate Band.
Introduced to redistribute wealth and generate public revenue, IHT is charged at a standard rate of 40% on the portion of the estate that exceeds the threshold.
Why do we have to pay inheritance tax?
The primary purpose of inheritance tax is to help fund public services by taxing wealth passed down through generations:
- Redistribution of wealth: IHT ensures that wealthier individuals contribute more to the state, potentially reducing inequality.
- Public revenue: It provides vital funding for healthcare, education, and infrastructure.
While some argue it’s a fair means of taxation, others see it as a double tax, as much of the estate may already have been taxed during the individual’s lifetime.
How does inheritance tax work?
Inheritance tax is assessed on the total value of the estate left behind by a deceased person. Executors or administrators of the will are responsible for calculating and paying IHT before the estate is distributed to beneficiaries.
What is the inheritance tax threshold?
The inheritance tax threshold is currently set at £325,000 (as of 2024):
- Any value above this threshold is taxed at 40%
- If the estate’s value is below £325,000, no IHT is due
There are additional allowances and exemptions:
- Residence Nil-Rate Band (RNRB): An additional £175,000 may be available if the deceased leaves their home to direct descendants (clawed back if the estate is worth over £2m).
- Spouse and civil partner exemptions: Transfers to a surviving spouse or civil partner are exempt from IHT.
- Charitable donations: If at least 10% of the estate is left to charity, the IHT rate is reduced to 36%.
- Lifetime gifts: Gifts made more than seven years before death are usually exempt.
Impact on beneficiaries
Inheritance tax can significantly affect the financial gains beneficiaries receive. Key considerations include:
- Reduced inheritance: The tax reduces the total value of assets distributed.
- Complex administration: Executors must handle IHT calculations and payments before assets are released.
- Financial pressure: In cases where the estate is largely made up of property, beneficiaries might need to sell assets to cover the tax liability.
Recent changes to inheritance tax laws
The UK government periodically reviews IHT rules to adapt to economic and social conditions. Recent updates include:
- Freezing of the Nil-Rate Band: The £325,000 threshold has been frozen from 6 April 2009 until 2028, meaning more estates may become liable for IHT due to rising property and asset values.
- Digital submission: The introduction of an online system for IHT reporting aims to simplify the process for executors.
- Budget 2024 changes: There were several changes announced by the new Labour government that will mean more estates are chargeable to IHT in the future.
Budget 2024 changes to inheritance tax
The new Chancellor, Rachel Reeves, announced several changes to the IHT regime that will increase the amount of IHT payable by many estates in the future:
- IHT thresholds will be frozen until 2030 (not 2028)
- Inherited pensions will be liable to IHT from 2027
- Agricultural Property Relief to reduce from 100% to 50% if worth over £1m on 6 April 2026
- Business Property Relief to reduce from 100% to 50% on shares not listed on recognised stock exchanges such as AIM and worth more than £1m from 6 April 2026
Planning for inheritance tax
Proper planning can help mitigate the impact of inheritance tax. Strategies include:
- Utilising lifetime gifts: Make use of annual exemptions (£3,000 per year) and consider larger gifts that fall under the seven-year rule.
- Leveraging spousal exemptions: Ensure both partners’ allowances are fully utilised by transferring assets effectively.
- Making charitable donations: Donations not only reduce the taxable estate, but also lower the overall tax rate.
- Seeking professional advice: A financial advisor or accountant can identify opportunities for tax efficiency tailored to your circumstances.
- Setting up trusts: Trust funds are an effective way to reduce the inheritance tax burden by removing assets from your estate. By placing assets into a trust, you can ensure they are no longer part of your taxable estate, potentially reducing the amount of IHT.There are various types of trusts, such as discretionary and bare trusts, each offering different benefits and levels of control for beneficiaries. Trusts also provide flexibility in how assets are distributed, allowing for protection and tax efficiency for generations to come.For those looking to explore the full potential of trust funds in their estate planning, it’s crucial to seek professional advice. 360 Accountants can guide you through the complexities of trust creation and management, ensuring your wealth is passed down efficiently, while minimising tax liabilities. Make an enquiry about trust funds with 360 Accountants.
If you have invested in pensions to avoid IHT, you should speak to your financial advisor as a matter of urgency.
While inheritance tax can be complex, it is a manageable aspect of estate planning. By understanding the rules, exemptions and strategies available, you can protect your wealth and reduce the tax burden on future generations.
