This article was written prior to the October 2024 Budget announcement. The treatment of pensions is subject to change from 6 April 2027
Inheritance tax has been the source of controversy over the past few years. Regularly intruding into fiscal or political debates, these have often caused much heat but little light. In this article, we seek to place this tax into context and describe how it works.
The amount of inheritance tax raised is at record levels according to HM Revenue & Customs (HMRC). In the last tax year, the Government raked in £7.1 billion, £1 billion more than the previous year – itself a record year too. As the Treasury commented, the tax “helps fund public services like the NHS and schools.”
Given the rocket boosters under house prices during the pandemic and the race for space, the lay observer would expect most estates to pay inheritance tax. Despite this, currently, only one in 20 estates pay it with the Treasury claiming that “more than 93% of estates aren’t expected to pay any inheritance tax in the coming years.”
What is Inheritance Tax?
Inheritance tax is a tax on the value of an estate – the property, money and possessions of someone who has died. It also covers worldwide assets for UK-domiciled residents. The tax is normally paid by the executor of the will from the funds of the estate within six months after the person has died.
Inheritance tax is calculated on the market value of assets held at the time of death, less any liabilities such as mortgages or other debts, and any funeral expenses. Inheritance tax can be charged at 40% on the value of the estate above the so-called nil rate band.
The Nil Rate Band Explained
HMRC gives everyone a tax-free limit for inheritance tax known as the nil rate band, a similar concept to the personal allowance for income tax. This is set at £325,000. This had been frozen until 2026 but in last year’s Autumn Statement, the Chancellor of the Exchequer extended this until 2028.
Below £325,000, no inheritance tax is due but above that level, HMRC can potentially tax 40% of the excess. HMRC gives an additional allowance of £175,000 if a home is left to direct descendants such as children or grandchildren. This is known as the residence nil rate band. In combination, therefore, each estate could have a total tax-free allowance of £500,000.
The residence nil rate band also applies if the deceased has downsized their property or moved into a care home. If the estate is worth more than £2 million, however, the residence nil rate band becomes less generous, declining by £1 for every £2 above £2 million.
Mitigating Inheritance Tax
Benjamin Franklin once remarked that “in this world, nothing can be said to be certain, except death and taxes.” But with inheritance tax, as with other taxes, it can be managed or offset with good planning and adherence to tax rules.
Estates can be left to a spouse or civil partner completely tax-free, along with their £325,000 nil rate band and the £175,000 residence nil rate band.
When the surviving partner dies, this will give their estate a combined nil rate band of £1 million – their nil rate bands added to their spouse or civil partner’s allowances. Only when this remaining partner passes away does any inheritance tax become due on the combined estate. It’s important to note these these provisions do not extend to unmarried couples.
Another key consideration is the seven-year rule for gifts from an estate before the person dies. Gifts will only be completely free from inheritance tax if the person giving it lives for another seven years. If gifts made from capital are made within the last seven years of their life, they are brought back into an estate for tax purposes.
Until April 2027, Inherited pensions are not subject to inheritance tax. If you die before 75, the pension can be passed on completely tax-free if withdrawn within two years. If you pass away after that age, the beneficiary will have to pay their highest rate of income tax on any withdrawals.
There are also tax reliefs for businesses, farms and agricultural property, woodlands, and heritage assets such as stately homes.
Over the coming months we will be carrying out a deeper dive into some of these aspects, and tax planning measures.
How Can We Help?
The intricacies of inheritance tax highlight the importance of careful planning.
Foxley Kingham can provide specialist help to plan your estate. Inheritance tax may be a less-than-welcome fact of life but with help to forward plan your finances, the amount of inheritance tax liable on your estate can be significantly reduced.
If you think your estate may be liable to inheritance tax, planning ahead can ensure the tax liability on what your beneficiaries receive is not greater than it should be. With our reliable, proactive support, we can make sure your tax position is the most advantageous it can be. Contact us now.
