The number of people paying inheritance tax is at its highest level in 20 years
Inheritance tax is seen as the most unfair tax in the UK, despite the small number of families who actually have to pay it.
A poll by Ipsos Mori for The Daily Telegraph found that 43% of British adults think inheritance tax (IHT) is unfair. Council tax and fuel duty were considered the next most unfair taxes.
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It comes as the government is reportedly considering scrapping the “divisive” tax as a “vote-winner” ahead of the next general election, added the newspaper.
The number of inheritance tax receipts is at its highest level in 20 years, according to HMRC data.
In the tax year 2020/21, there was a 17% increase in the number of deaths resulting in an IHT charge compared with the previous year, with 27,000 estates being subject to the charge, according to HMRC. The amount raised from IHT increased by £800 million, or 16%, to £5.76 billion.
Inheritance tax may be associated with people “leaving behind country mansions and grand estates”, said The Money Edit, but with rocketing house prices and a freeze on tax breaks, “more families will be left facing an inheritance tax bill when a loved one dies”.
Increasing numbers of people are facing IHT bills, but there are ways to reduce your estate’s tax liability before you pass away.
Who pays inheritance tax?
IHT may be Britain’s most hated tax, said The Times Money Mentor, but HMRC’s most recent figures show just 3.73% of estates actually paid it.
IHT is charged at a “whopping 40% on everything you leave above a certain limit” when you die, explained The Money Edit. Taxable assets include your home, car, savings and possessions. Unlike with income tax, there’s no “sliding scale”, the financial website added.
The politics of IHT are controversial, said MoneySavingExpert. The argument for the tax is that it “redistributes” inherited wealth, so instead of it only benefiting the children of the rich, “some of the money goes to the state to be distributed for the benefit of all”.
But critics say tax was already paid when the money was earned, “so to pay tax on it again isn’t fair”.
Scrapping IHT is rumoured to be among the “Conservative Party’s offering to voters” at the next general election, said The Times.
Getting rid of IHT would cost the Treasury “about £7 billion a year”, said the paper. This would make it a cheaper option that a 2p cut in income tax, which would deprive the Treasury of about £13.7bn, added the newspaper. It could also be a “boon in blue wall seats in the south of England”.
However, people do not have to wait for reforms to take place. There are ways to reduce your IHT bill and pass more money on to your loved ones without giving it to the taxman.
Inheritance tax allowances
Everyone has an inheritance tax allowance of £325,000, which is known as the nil-rate band.
This may seem like a generous amount, said The Money Edit, but the rate at which property prices are rising means “far more people would now be subject to the tax”, especially if they have other investments and assets as well as property.
There is also an extra allowance if you leave your home to your children or grandchildren. This is called the residence nil-rate band, and it is currently set at £175,000.
Husbands, wives and civil partners can also leave assets to one another tax-free, regardless of the amount. Making the most of this in your will can save your family a small fortune, said Which?. It also means that if none of the allowance is used, two parents could pass on £1m to their children tax-free when they combine the nil-rate band and the main residence allowance.
How to reduce your inheritance tax bill
There are many legal ways to “dodge the dreaded 40 per cent ‘death tax’”, said This Is Money, but it is only worth the effort if you are “certain you are rich enough for it to become a problem for your family”.
The first thing to do is to make a will, said The Times Money Mentor. If you don’t state how you want your assets to be divided, the law decides for you so “even more than necessary could end up going to the taxman”.
Spending or giving away your money during your lifetime is also “one of the simplest things you can do” to avoid paying IHT, added Which? as “no tax is due on any gifts you give, as long as you live for seven years after giving them”.
If you die within seven years and the gifts are above your tax-free allowance, your estate will pay a reduced tax rate known as taper relief depending how long ago you gave the money.
Giving money to charity, political parties or local sports clubs also reduces your estate’s IHT bill. If you leave more than 10% of your taxable estate to one of these groups in your will, the inheritance tax rate for the rest of your estate will fall from 40% to 36%.
ISAs are also a great way of keeping the taxman away from your savings while you’re alive, but they’re also tax efficient when you die, said YourMoney, “assuming you’re survived by a spouse”.
It may also be worth putting more money into a pension because they normally fall outside of a person’s estate, said Hargreaves Lansdown, “meaning there’s usually no inheritance tax to pay on them”.
A pension can be passed on to a beneficiary that you name when you start saving. Any withdrawals your beneficiaries make will usually be free from income tax, but only if you die before age 75.
Another option is to set up a trust. When you put money or property into a trust, said MoneyHelper, provided certain conditions are met, “you no longer own it.” Instead, the cash, investments or property belong to the trust and are outside anyone’s estate for IHT purposes, although you can decide how and when assets are distributed.
If you are worried about your children or grandchildren wasting the money, you could dictate that they gain access to their trust only when they turn 25.
Thousands of families needlessly pay IHT on life insurance payouts, said The Daily Telegraph. The policyholder can “easily avoid” doing so by making a “phone call to a provider and a small amount of paperwork” to set up a trust so the money received is tax-free.
It is important to seek advice on setting up trusts as they can be “expensive to run and subject to tax charges”, Laith Khalaf, head of investment analysis at AJ Bell, told MoneyWeek. If your estate is still set for a large IHT bill, you can buy an insurance policy that covers the liability.
“This route offers you peace of mind that your beneficiaries won’t struggle with a huge inheritance tax bill when you die,” Khalaf told the financial publication, “but you are effectively paying at least part of that bill while you are alive through your monthly premiums, which can be substantial.”
Marc Shoffman is an award-winning freelance journalist, specialising in business, property and personal finance. He has a master’s degree in financial journalism from City University and has previously written for FTAdviser, ThisIsMoney, The Mail on Sunday and MoneyWeek. This article is based on information first published on The Week’s sister site, The Money Edit.
