Can I reduce my family’s Inheritance Tax bill?

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What is Inheritance Tax (IHT)?

Of all the various taxes levied in the UK, Inheritance Tax (IHT) is one of the most peculiar.

For a start, its name is misleading. In other countries that levy inheritance taxes, the tax is usually based on the inheritor (or the beneficiary) and the amount that they inherit. In the UK, the tax would be more accurately described by its former name, capital transfer tax. Think tanks regularly suggest IHT should change from a levy on donors to a tax on recipients. In theory, the switch would encourage a wider distribution of assets. It could also raise considerably more revenue.

IHT is often described as the UK’s most hated tax. Former Chancellor, Lord Jenkins once called inheritance tax “a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”.

However, the amount of tax it raises for the Exchequer is small: it is worth about 1%  of the total produced by the three main taxes – income tax, national insurance, and VAT.

The vast majority of estates do not pay any IHT. For married couples and civil partners who are homeowners with children, IHT is usually not an issue until their wealth exceeds £1 million. Statistics from HMRC show that in 2019/20, only 3.76% of estates suffered the tax. In practice, nearly half of estates will escape IHT simply because there is generally no tax on transfers between married couples and civil partners. However, this exemption does not apply to unmarried couples as, with IHT there is no such concept as a common-law spouse, and the number of estates now liable for inheritance tax is on the up.

Why are more families having to pay IHT?

New figures from HMRC show that in 2021/22 IHT receipts rose by nearly 14% , with the average IHT bill faced by that small minority of taxpaying estates at a value of just over £250,000. One reason for the increase is the fact that the nil rate band is frozen.

Currently everyone has a tax-free inheritance tax allowance of £325,000 – known as the Nil-Rate Band. The standard inheritance tax rate is 40% of your estate over the £325,000 threshold.

The freeze started in 2009 and its term has regularly been extended – the “thaw” is not now due to arrive until April 2026 which will be 17 years! With inflation surging, over three more years of freeze will drag more estates into the IHT net.

What can I do to protect against any IHT bill?

If IHT is a concern for you, there are a variety of ways to reduce its impact on what your children or grandchildren will inherit. It will not surprise you to learn that with such a misunderstood tax, the starting point is professional advice. A good Independent Financial Adviser will often work in conjunction with a Solicitor. They will ensure that a client’s estate planning is correctly set up, based on their wishes and objectives, and regularly reviewed, especially as the law can change.

For the majority of people there are various approaches that can be taken to mitigate a future IHT liability.

Of course, you could choose to ignore it. If there is tax for your family to pay later on so be it. On the other hand, you could choose to spend enough money during your lifetime so that little or nothing is left in your estate. However, this approach may be easier said than done!

If either of these approaches don’t suit you then there are other steps to consider and we discuss these in Our Guide to Inheritance Tax and Estate Planning.

At Armstrong Watson our quest is to help our clients achieve prosperity, a secure future and peace of mind. We provide bespoke tax planning, financial planning and wealth management all under one roof. Please note, advice on IHT related matters could be provided by a mixture of both our financial planning and tax specialists.