Inheritance is a topic that generates strong opinions and often deep-seated concerns amongst family , but it can be very difficult to talk about. As the name suggests, inheritance tax is a tax payable to HMRC on the assets that you leave behind for your loved ones after you away.
With suggestions that the current government may seek to reduce or abolish inheritance tax in the media of late, and what was once seen primarily as a tax on the rich now having an impact on more of us than ever thanks to the significant rise in property prices in recent years, we explore how inheritance tax works, the current inheritance tax thresholds in the UK, and the anticipated changes to this unpopular tax in future.
How does inheritance tax work?
Inheritance tax, often abbreviated as IHT, is a tax imposed by the UK government on the estate of a deceased person. The tax is levied on the value of the deceased person’s assets, including property, investments, cash, and other personal possessions. In essence, it is a tax on the transfer of wealth from one generation to the next.
The primary objective of inheritance tax is to generate revenue for the government and see that wealth is distributed fairly across society, preventing the accumulation of dynastic wealth by taxing large estates. However, for many, inheritance tax can be a significant financial burden, and the tax is seen as an unfair penalty on assets which will have already been subject to tax during the individual’s lifetime.
However, you will not always have to pay tax when you inherit money or other assets. As with most taxes, there is a threshold for paying inheritance tax.
Current inheritance tax thresholds
The current inheritance tax thresholds in the UK are as follows:
- Nil-rate band: The nil-rate band is the threshold at which an individual’s estate becomes subject to inheritance tax. The nil-rate band is currently £325,000. This means that if your estate is valued at less than £325,000, no inheritance tax is payable.
- Residence nil-rate band: In addition to the standard nil-rate band, there is also a residence nil-rate band (RNRB) which was introduced in April 2017. The RNRB is designed to reduce the inheritance tax liability for individuals leaving their main residence to direct descendants, such as children or grandchildren. This includes adopted, foster or stepchildren. The RNRB is currently £175,000.
- Combined threshold: If you are eligible for both the nil-rate band and the residence nil-rate band, your combined threshold is £500,000. This means that an individual with an estate valued at less than £500,000 may not have to pay any inheritance tax.
The value of your estate is calculated by adding up the value of all your assets and subtracting any debts and liabilities. If your estate exceeds the relevant thresholds above, the excess is subject to the standard 40% inheritance tax rate.
What are the exceptions when it comes to inheritance tax?
If your estate is worth over £325,000, there would still be no tax payable if you were to leave any amount over the £325,000 to a spouse, civil partner, a charity, or a community amateur sports club.
A married couple can also share their tax-free allowance, which means they can therefore on £1 million in assets to their direct descendants without having to pay any inheritance tax.
You can also reduce the inheritance tax rate from 40% to 36% if you leave 10% of the value of your assets over the £325,00, after any deductions, to a charity. There is also relief available on the business assets of an estate as well.
Giving assets – including property – as a gift to your loved ones while you are still alive is another way to avoid a hefty inheritance tax bill, although there are instances when these gifts are still liable for inheritance tax, so do make sure you are aware of the rules on giving gifts.
Anticipated changes to inheritance tax
In the ill-fated Autumn 2022 statement, the then Chancellor, Kwasi Kwarteng, extended the period for the current inheritance tax threshold from 2026 to April 2028. However, more recently, it has been suggested that the government plans to cut the inheritance tax rate of 40%, with the view to potentially eliminating the tax completely in future. Whilst this has not been confirmed by the current Prime Minister or Chancellor, and no timescale has been suggested, any changes are likely to come into effect in the Spring Budget in March 2024, according to The Times.
Given that tax policies and regulations are always subject to change, regardless of the party in government, it is essential to stay informed on current tax thresholds and the implications for your personal situation.
To get the most up-to-date information on proposed changes to inheritance tax visit https://www.gov.uk/inheritance-tax and seek advice from a qualified financial advisor to assess the potential impact of any changes on your estate and inheritance tax liability.
