Why inheritance tax isn’t the villain it’s made out to be

Inheritance tax is ‘the most hated tax in Britain’ – many are likely to be relieved, then, to hear that the government is considering abolishing the tax if they win the next election. Although the Chancellor made no new announcements... Read more

Family cooking together

Blog29th Nov 2023

By Ian Campbell

Inheritance tax is ‘the most hated tax in Britain’ – many are likely to be relieved, then, to hear that the government is considering abolishing the tax if they win the next election. Although the Chancellor made no new announcements in the recent Autumn Statement, it is still believed that the government would like to announce changes in the next budget.

“People know that there’s something deeply unfair about being taxed all their lives and then being taxed in death as well,” said defence secretary Grant Shapps.

It’s easy to see why people might resent the taxman for taking a chunk of their children’s inheritance. When most people hear the words ‘inheritance tax’, they assume that 40% of their estate will be deducted soon after they pass away. But IHT is, in fact, largely misunderstood. Figures from the Treasury show that only 3.73% of UK deaths result in an inheritance tax charge.

The inheritance tax system is much more complex than it may initially seem, due to a series of exemptions designed to protect smaller estates and family homes. If you’re wondering what impact inheritance tax will have on your estate, here’s what you need to know.

The first £325,000 of your estate is usually protected – more if you’re a homeowner and parent

It’s true that eligible estates are typically taxed at a rate of 40%, but each individual has what’s known as a ‘nil-rate’ allowance of £325,000 (£500,000 if they leave their main home to a direct descendant). This means that those who pass away with an estate worth less than their allowance won’t pay any inheritance tax at all.

The £325,000 threshold hasn’t been raised since 2009. This can be particularly frustrating for those who come from humble beginnings and bought a home when prices were much lower than they are today. A property bought for £18,000 in the late 1980s, for example, can be worth much more than £500,000 today.

Married couples and civil partners get preferential treatment

If you’re married or in a civil partnership, you can inherit your spouse/civil partner’s entire estate without paying a penny in inheritance tax. You can also inherit any unused IHT allowances from your spouse, meaning you could have a total allowance of up to £1m if you pass your home onto your children or grandchildren.

Unfortunately, the system is less rewarding for unmarried couples. If you pass away without tying the knot, your partner may be hit with an inheritance tax charge if your estate is over the nil-rate (and residence nil-rate) band.

Different rules apply for those with estates worth £2m or more

If your estate is worth more than £2 million, your residence nil-rate band will be reduced by £1 for every £2 over the £2 million threshold. If your estate is worth more than £2.35 million, the residence nil-rate band won’t apply. Don’t worry if this applies to you. Thanks to a number of other exemptions and estate planning strategies, it’s possible to gift and spend your way to a smaller tax bill.

You can reduce your tax bill by giving generously while you’re alive

Instead of passing on a sizable inheritance, it can make financial sense to spoil your loved ones while you’re alive. Pay for those driving lessons, top up their house deposit (something our client Gary chose to do) and help them fund the wedding of their dreams — your money will go further if you give with a warm hand.

You can give as much as you like to family or friends while you’re alive, though the taxman might get involved if you pass away within 7 years of giving a large gift.

If you don’t reach the 7-year mark, the tax will be charged on a sliding scale depending on how recently you made the gift. If you pass away within 3 years, for example, it’ll be taxed at the full rate of 40%. This rate gradually reduces each year.

As if that wasn’t complicated enough, there are additional rules. You can give away £3,000 a year without having to worry about paying inheritance tax on it when you pass. Even if your time comes within 7 years of giving the gift!

You can also 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. Confusing, yes?!

You can give each child £5,000 for a wedding and each grandchild £2,500 when they tie the knot. Combine these wedding gifts with the annual £3,000 exemption and you could make an £8,000 wedding gift each year.

Donations to charities or political parties are also exempt from inheritance tax. If you leave 10% of your estate to charity, you’ll be taxed at a lower rate of 36%.

Inheritance tax offers a valuable life lesson

As confusing as inheritance tax can be, its complexity tends to work in most people’s favour. Those with small estates are unlikely to pay it, while those with large estates can often reduce their tax bill anyway with good financial planning.

One of the most challenging things about planning for retirement is finding the perfect balance between having enough and having too much. You want to be protected in case you live to 100, but you don’t want the taxman taking a huge cut if you don’t.

If this sort of thing keeps you awake at night, we can help! We’ll work out how much you need, put protections in place in case you live longer than expected, and help you make the most of your money while you’re alive and kicking.

For all its flaws, perhaps inheritance tax offers a valuable lesson. Hoarding huge amounts of wealth in the hope of passing it onto the next generation is a risky endeavour. Since you can’t take it with you, you may as well enjoy it while you can.

SPEAK TO US TO FIND OUT MORE ABOUT how inheritance tax could impact your estate.

By Ian Campbell

Sign up to updates

  1. Blog21st Jun 2023

    6 things you need to know about pension planning

    Think you’ve seen everything you need to know about the changes to tax and pensions for the financial year? Behind the headlines are some important things you need to consider for your pension planning. And some you may have missed.... Read more

    By Ian Campbell

    View more
  2. Blog23rd Jan 2023

    Couple sitting together, financial planning, budgeting, savings, forecast, state pension

    Update your financial checklist for 2023

    Summary: Here are some simple things you can do to help maximise your wealth. Welcome to the new year! How are you approaching 2023 so far? It’s of course traditional around this time of year to try and become healthier.... Read more

    By Ian Campbell

    View more
  3. Blog26th Sep 2022

    People playing golf, golf course, outdoors, Happy

    How much is enough?

    Professional golf is a sport awash with money. The top stars earn millions. Tiger Woods, surely the world’s most famous golfer, has earned more than US$120 million from his PGA tour career alone. Most of the big hitters can expect... Read more

    By Ian Campbell

    View more
  4. Blog21st Jun 2022

    Investment and Market Update

    The news today can feel a little bit unsettling. There is no doubt that these are tough emotional times for investors.  Russia’s invasion, and brutal war in Ukraine, is unsettling on both a human and an economic level.  The plight... Read more

    By Ian Campbell

    View more

Share this page