Inheritance tax explained — the basics, suggested reforms and how to plan ahead

Talk around inheritance tax in the British Press is always a topic that grabs attention. Most recently, both the current Government and Labour Party have hinted at reform — leading to more people thinking about inheritance tax and how any changes could impact their position.  

Here, Paralegal Abbie Johnys explores the suggested reforms and how you can plan ahead. 

What is inheritance tax?

Inheritance tax is a tax charged on an estate of someone who has died, though it may sometimes be payable on lifetime gifts and trusts.

The first £325,000 (the nil rate band) of any estate is usually tax free, with an additional £175,000 allowance (the residence nil rate band) available against the value of the deceased’s main residence (only if this is left to a direct descendant, like a child or grandchild and subject to the size of the deceased’s estate). This means that an individual’s estate could benefit from a £500,000 tax-free allowance.

This tax-free allowance may be up to £1m for married couples, as it’s possible for any nil rate band and residence nil rate band allowance that wasn’t used on the death of the first spouse/civil partner to be transferred to the surviving spouse/civil partner’s estate. 

Any value of the estate not covered by these allowances is typically charged at a 40% tax rate. Certain assets in an estate — or the value of assets that are being left to certain beneficiaries — can qualify from exemptions or reliefs, which mean that they aren’t subject to inheritance tax (in whole or in part). Examples of such reliefs or exemptions include business relief, agricultural property relief and gifts to charity or a spouse. 

When it comes to reviewing how much inheritance tax an estate will be charged, the devil is always in the detail. There are several factors that you must bear in mind, including lifetime gifts in the seven years before death (which can reduce the nil rate band available) or the value of the estate (which could taper the amount of residence nil rate band that it benefits from). These elements may mean that specialist estate planning advice is required. Having a clear plan and the right advice can also help your family and friends when it comes to administering your estate. 

Who does inheritance tax affect?

According to Government statistics, inheritance tax generated £7.5bn in the tax year 2023/24 — and this is continuing to increase year-on-year. This report   also comments on the use of exemptions and reliefs, noting that more individuals are making sure to structure their estates during their lifetime in order to benefit from a lower inheritance tax bill on their death. 

With the inheritance tax-free thresholds remaining the same since 2009 and property prices rapidly increasing, the Office for National Statistics is seeing ever more estates facing an inheritance tax bill. 
 

What are the suggested reforms? 

With reform in the air, more estates could soon be subject to inheritance tax — increasing the amount generated each tax year for HMRC.

While the Government is yet to present its proposals, there has been much speculation, including around:

1. Simplifying the current regime. This could mean that lifetime and death transfers are subject to a lower flat tax rate of 10%, removing the seven-year rule on lifetime transfers, affecting rules on gifts with the reservation of benefit or pre-owned assets and — crucially — increasing the burden on lifetime gifts and the tax that becomes immediately payable. 
2. Ending business and agricultural property relief. These reliefs are highly valuable and said to account for £4.2bn in tax savings each year. This could have an impact on business ownership and succession.
3. Changing the charity exemption. It was suggested that there would be no reduced tax rate of 36% where more than 10% of the estate is left to charity. This relief accounts for £1.8bn in exempt estate value each year.
4. Increasing the nil rate band (currently £325,000). This has been frozen since 2009. Rising property prices mean that some estates become subject to tax solely because of the property.
5. Reforming the residence nil rate band. This has been in place since 2017. It doesn’t always fit with the modern family picture or those who don’t have children, as such people can’t benefit from this tax-free allowance against their property. This is also unavailable where the value of an estate is broadly over £2m.
6. Abolishing inheritance tax. Perhaps the most drastic proposal, on the face of it, this seems like a crowd pleaser — especially as inheritance tax is widely regarded as Britain’s most disliked tax. However, according to the Institute for Fiscal Studies, the current cost of abolishment alone is a whopping £7bn — and complete abolition would lead to an annual gap of £6bn in the public purse. One argument for abolishment is that it results in double taxation. People have already paid tax when building up their estate to support themselves and their family — and on death, they’re paying tax again (sometimes on the same assets). With inheritance tax generating a considerable amount of income for the Government (£600m in July 2023 alone), it leads one to wonder whether abolishment could lead to other taxes being increased to recoup the loss. 

Planning ahead

While it seems like inheritance tax is in need of reform, only time will tell which changes become reality. 

Unfortunately, no one has a crystal ball and the exact inheritance tax liability that an estate will pay is dependent on the date of death, circumstances at that time and the current laws in place. 

However, planning ahead can help you to retain control and as much of your accumulated wealth as possible for your beneficiaries. 

You should consider:

• Making a Will and keeping this up to date.  
• Making gifts during your lifetime. 
• Understanding the reliefs on offer and checking whether you’ll meet the requirements to qualify for said on relief on death.
• Using a trust. 

These are just some of the tools you can use to plan ahead. It’s important for us all to take steps to ensure that our estates are protected for when we’re no longer here. Taking proactive steps to ensure that your affairs are in order is always a good place to start. 

To find out how you can protect your estate and family, talk to our team today.