The Treasury is raking in a record amount from inheritance tax (IHT) and more families than ever must pay the death levy thanks to frozen thresholds and inflated house prices.
Between April and August this year, HMRC collected £3.2 billion in IHT, about £300 million higher than in the same period last year. IHT receipts in June were the highest monthly total on record.
The tax is a controversial topic for some voters, who feel they are effectively being taxed twice on top of income tax paid throughout their lifetime. IHT has not been reformed in six years, but the government is now considering abolishing it altogether.
Here’s everything you need to know about who pays IHT, on what assets and how you can avoid it.
What is IHT?
IHT is typically levied at a rate of 40 per cent on the value of an estate above the “nil-rate” allowance of £325,000 (£500,000 under the residence nil-rate band, if you leave your main home to a direct descendant). Your estate is the total value of everything you own — properties, savings (excluding pensions) and valuables such as artwork or jewellery.
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The £325,000 threshold has not been raised since 2009, despite years of house price rises and asset inflation. The average house price in 2009 was about £178,000 — today it is roughly £286,000.
How much money can you inherit without paying tax?
If your estate is worth less than the nil-rate band allowance of £325,000 you will not have to worry about inheritance tax. If you leave your home to a child or grandchild, your estate additionally gets the £175,000 residence nil-rate band.
You start to lose the residence nil-rate band if your estate is worth more than £2 million — it is reduced by £1 for every £2 above £2 million and you lose it altogether if your estate is worth more than £2.35 million.
Who is exempt from IHT?
If your spouse or civil partner dies, you can inherit their entire estate IHT-free. If you are part of a couple but not married when your partner dies, you will have to pay IHT if you inherit their estate and it is worth more than £325,000.
You can inherit any unused IHT allowances from your partner, meaning a couple has a total allowance of up to £1 million (including the residence nil-rate band).
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Donations to charities or political parties are also exempt from IHT. If you leave 10 per cent of your estate to charity the rate paid on the rest of your estate falls from 40 per cent to 36 per cent. Funeral expenses can also be deducted from the value of your estate.
How is IHT paid?
The tax must be paid to HMRC within six months of the person’s death and will be arranged by the executor of a will, using funds from the estate. If there is no will then the closest living relative can apply to be the estate administrator through the government’s probate service.
If money is tied up in property that is not sold within six months, an executor can pay the IHT due and claim it back from the estate or you can arrange with HMRC to pay the bill in instalments, but the tax office will charge interest.
When was IHT last reformed?
IHT was last reformed under George Osborne in his 2015 budget when he introduced the residence nil-rate band — a valuable allowance that adds an extra £175,000 to your tax-free allowance when you leave your main home to children or grandchildren, including adopted, fostered or stepchildren. The reforms took effect from 2017 and meant a married couple could leave an estate worth up to £1 million without having to pay IHT.
Last year chancellor Jermey Hunt said he would not increase the nil-rate band threshold until at least 2028, dragging more families into paying the death tax.
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How bills can be reduced
There is nothing to stop you giving away assets or money during your lifetime. If you live for seven years after making a gift it will not be counted as part of your estate for IHT purposes.
If you die within seven years the value of the gift may be added to your estate for tax purposes and IHT will be charged on a sliding scale. Gifts given in the three years before your death will be taxed at the full rate of 40 per cent, but this gradually reduces until the seventh year.
Every year you can give away £3,000 without having to worry about paying IHT and you can give as many gifts of cash or assets worth £250 as you like, as long as you haven’t used another gift allowance on the same person that year.
You can also give £5,000 to a child for their wedding, and grandparents can contribute £2,500. This can be given on top of the annual £3,000 exemption, so you could make an £8,000 wedding gift.
Investing in companies that qualify for business relief also has benefits. You can invest in private firms or companies listed on the Alternative Investment Market and, as long as you have held the investment for two years when you die, they will be exempt from IHT.
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Business owners can also make use of business relief, which allows a company to be transferred to family members or beneficiaries free of IHT.
Investing in companies that qualify for business relief can also reduce a tax bill. You can invest in private firms or companies listed on the Alternative Investment Market and, as long as you have held the investment for two years when you die, they will be exempt from IHT.
