Introduction
Many people believe that inheritance tax (IHT) is a tax that only impacts the super-rich, but the truth is that IHT is a concern for more families than you might think. Rising property values, the complexities of family wealth, and a lack of awareness about IHT thresholds mean that many middle-class individuals and families will face this tax at some point. If left unaddressed, IHT can erode the value of your estate and reduce the legacy you leave behind.
In this article, Steve Rowe dispels common myths about IHT and provides you with clear, practical steps on how to minimise its impact. Whether you're an individual planning for the future, a business owner concerned about the family business, or someone navigating a change in your personal circumstances (such as divorce), understanding how IHT works and how to plan for it is crucial.
How IHT Works & Why We Have to Pay It
Inheritance tax is a tax on the estate of someone who has passed away. The estate includes property, savings, investments, and possessions. IHT is levied on the value of the estate above the IHT threshold, which is currently set at £325,000 and hasn’t risen since 2009 and not due to until 2028…and even then, if might not! If the value of your estate exceeds this threshold, the excess will be taxed at 40%. This is how IHT may affect you, as your assets rise but the tax-free part does not.
IHT was introduced as a way of redistributing wealth, and while it has been the subject of debate, it is still an important source of revenue for the government. The tax is intended to apply to estates that are above a certain value, with the aim of taxing wealth that passes between generations.
IHT Tax Thresholds – How Much is Inheritance Tax?
The IHT threshold refers to the amount above which inheritance tax will be charged. The standard threshold is currently £325,000. If the total value of your estate is below this amount, your beneficiaries won’t need to pay any IHT.
However, many people don’t realise that certain assets can be exempt from IHT, or that there are allowances that can increase the threshold, such as the residence nil-rate band. This means that a married couple or civil partners could potentially pass on £650,000 tax-free if they utilise their combined thresholds.
The key point here is that more people are falling into the bracket of taxable estates, especially with the rising value of homes, which often pushes estates over the IHT threshold.
Check out this link for the Gov Website
"Many people mistakenly believe that inheritance tax only affects the super-rich. In reality, rising property values mean that more middle-income families are finding themselves liable for IHT, often without realising it until it’s too late."
Luke James, Chartered Financial Planner with Lucent Financial Planning.
Understanding the IHT Rate
The IHT rate is set at 40%, but this applies only to the value of your estate that exceeds the threshold. For example, if your estate is worth £500,000, the first £325,000 would be tax-free, and the remaining £175,000 would be taxed at 40%, meaning £70,000 would go to HMRC.
If you leave your main residence to direct descendants, then you would also be able to claim the ‘Main Residence Nil Rate Band’ which is £175,000.
As a married couple, if both of you are able to claim this, then potentially £1Million of your estate could be let without inheritance tax.
However, there are ways to reduce the IHT rate. For example, if you leave at least 10% of your estate to charity, the IHT rate on the rest of the estate can be reduced to 36%. This gives you an opportunity to reduce your tax burden while also supporting causes that are important to you.
Who Pays the Tax to HMRC?
The inheritance tax is paid by the estate, not directly by the beneficiaries. The executor of the will or the personal representative is responsible for ensuring that the IHT is paid to HMRC before distributing the estate to the heirs.
This process can take several months, as the estate’s value is determined, and the necessary paperwork is completed. If the IHT is not paid on time, interest and penalties may be applied.
Why Some People Feel So Strongly That IHT Is Unfair
Many people view inheritance tax as unfair, particularly because they see it as double taxation. Assets that have already been taxed during a person’s lifetime (like property and savings) are subject to IHT when passed down to heirs. For some, it feels like being taxed twice for the same wealth.
Additionally, the perceived unfairness of IHT is heightened by rising property values. Many middle-income families find that their homes once considered modest now exceed the IHT threshold, making them liable for tax they didn’t anticipate.
Despite these concerns, IHT is a tax that, when planned for, doesn’t have to reduce the amount passed on to heirs significantly.
5 Common Myths About Inheritance Tax
1. Inheritance Tax Makes Up a Large Portion of HMRC Receipts
A common myth is that inheritance tax represents a significant portion of the government’s revenue. In reality, IHT contributes a relatively small fraction of HMRC’s receipts, typically under 1%.
2. Only the Super-Rich Will Need to Pay Inheritance Tax
Many people believe that IHT only affects the very wealthy, but this is no longer the case. Rising property prices mean that many middle-income families, particularly those with family homes, will fall into the IHT net. With the value of a home often exceeding the £325,000 threshold or £500k for a single person leaving home to a direct descendant, IHT is becoming more common among ordinary households.
3. "You Can Pass on £1 Million Before Inheritance Tax Is Due"
This myth likely stems from the combination of the nil-rate band and residence nil-rate band, which together can allow for up to £1 million to be passed on tax-free. However, this is not the case for everyone. The full £1 million threshold only applies if both partners are using their exemptions and if the estate meets certain conditions, such as leaving the family home to direct descendants.
4. "You Don’t Need to Consider Inheritance Tax if You Leave Everything to Your Partner"
While spousal transfers are exempt from IHT, this doesn’t mean that there won’t be IHT due when the surviving spouse passes away. The surviving spouse will still be subject to IHT on their own estate, including the assets they inherited.
5. Gifted Assets Aren’t Liable for Inheritance Tax
Gifts made during a person’s lifetime are subject to IHT if they exceed the annual exemption (£3,000) or if they are made within seven years of death. These gifts can be taxed under the seven-year rule, and failing to document them properly can cause problems for the estate.
6. "You Can Leave Your Home to Children Without Paying Inheritance Tax"
The residence nil-rate band allows you to leave your home to direct descendants without IHT, but this exemption is subject to various conditions. If your estate exceeds certain thresholds, or if you don’t leave the home to children, this exemption may not apply.
7. "Assets Held Abroad Will Not Be Liable for UK Inheritance Tax"
Assets held abroad can still be subject to UK IHT, depending on your domicile status. If you’re domiciled in the UK, your worldwide assets will be liable for IHT, regardless of where they’re located.
What Steps Should I Take to Minimise My IHT Burden?
There are several steps you can take now to reduce the IHT burden on your estate:
- Plan Early: Starting your IHT planning early gives you more time to utilise the exemptions, make gifts, and set up trusts.
- Gifting: Making regular gifts during your lifetime is one of the simplest ways to reduce your estate’s value and minimise IHT. Take full advantage of the £3,000 annual exemption and other gift allowances.
- Trusts: Setting up trusts allows you to transfer assets out of your estate and protect them for future generations. This can help reduce the taxable value of your estate.
- Life Insurance: Consider taking out life insurance to cover the potential IHT liability. This ensures that your beneficiaries won’t be forced to sell assets to pay the tax.
- Charitable Donations: Leave part of your estate to charity to reduce your IHT liability and benefit from the reduced IHT rate.
Learn more in our article how do I leave a meaningful legacy without a tax burden
"The key to reducing your inheritance tax burden is early planning. By taking advantage of exemptions and using tools like trusts and gifts, you can significantly reduce the tax your estate will pay, ensuring more of your wealth is passed down to the next generation."
Ellie Pemberton – Independent Financial Planner at Lucent Financial Planning
When Should I Seek Professional Advice About IHT?
IHT planning can be complex, especially if your estate involves business interests, overseas assets, or complicated family dynamics. If you’re unsure about your options or need help navigating the rules, seeking professional advice is essential. A financial planner or estate lawyer can help you understand the nuances of IHT planning and provide guidance tailored to your situation.
Conclusion
Inheritance tax doesn’t just affect the wealthy; it’s a concern for more people than you might think. By understanding the myths and getting to grips with how IHT works, you can take proactive steps to minimise its impact on your estate. Early planning, regular gifting, setting up trusts, and seeking professional advice are all effective strategies to reduce your IHT liability and leave a meaningful legacy.
Don’t wait until it’s too late start planning today to ensure that your wealth is passed on as efficiently as possible, without unnecessary tax burdens.
Disclaimer: This article does not constitute financial advice. We recommend that you speak to a qualified financial planner for advice tailored to your individual circumstances and goals. Financial markets may go up or down, and you are not guaranteed a return on your investment. Past performance is not necessarily a guide to future performance.
