- Although the headline rate of IHT is 40%, the average effective rate of tax paid by estates is 13%, according to HMRC figures
- Families can make use of exemptions, reliefs, gifts and allowances to mitigate IHT
- Exempt transfers between spouses accounted for 68% of the value of all exemptions and reliefs
- Other reliefs for business and agriculture assets help shelter £4.4bn of assets from the taxman
- Almost 10,000 families give to charity from their estate, helping reduce IHT
- How do families plan for IHT and pass on money to loved ones?
“Earlier this month the taxman confirmed that total IHT receipts hit a record £2.1bn for the opening quarter of the 2024-25 tax year and HMRC figures published this week show the number of estates paying IHT is climbing,” says AJ Bell pensions and savings expert, Charlene Young.
“The growing tax take is driven by rising asset prices and a frozen thresholds for both the nil rate band and residence nil rate band – both key allowances that help shelter assets on death – which means more estates are subject to IHT.
“The proportion of estates paying IHT now stands at just under 4.4%, it’s highest level since 2016/17 when the RNRB was first introduced.”
Effect of frozen thresholds
“Taxpayers have had to get used to fiscal drag and, although it’s a phenomenon normally associated with tax on incomes, families inheriting money will feel an impact too.
“Frozen thresholds and rising asset values mean more estates are paying IHT than ever, up to 27,800 in the 2021/22 tax year, an increase of 3% from the year before.
“Everyone can pass on up to £325,000 before any IHT is due, although this IHT nil rate band has been frozen since 2009. The residence nil rate band (RNRB) has been available since 2017 and gives a boost of up to £350,000 per couple if they leave a property to their descendant(s). Had both bands been uprated with inflation rather than being frozen in 2020, a couple could pass on an estate worth £1,423,000 combined after the second person died.
The effective rate of IHT paid by estates
“The impact of reliefs and allowances can be seen in the effective tax rates paid by estates with an IHT liability.
“Although IHT is payable at 40%, the average effective rate for estates in 2021/22 was 13%, thanks to the combination of tax-free allowances, exemptions, and reliefs used.
Source: HMRC (average effective tax rate (AETR) for taxpaying estates; tax years 2016/17 to 2021/22)
“The effective rate was lower for smaller (taxed) estates – at around 4% - but rises as the value of the estate goes up. The families paying the heftiest death duties to the taxman hand over more than 25%.
“The worst hit tend to be estates worth around the £3-4 million mark, due in part to the fact that the RNRB is tapered down for estates worth over £2 million and is lost altogether over £2.7 million. For estates worth over £2 million the effective rate was an average of 24%.
“However, the effective tax rate actually then falls for larger estates. That’s because larger estates tend to be more likely to be in a position to make use of reliefs for farmland and business assets.
Spousal transfers top the list of exemptions
“Aside from the universal nil rate band, and the potential to use the additional residence option to increase it, investors can make plans in their lifetimes to benefit from reliefs and exemptions when they die and pass on wealth.
“The largest exemption continues to be for transfers between spouses and civil partners. These were worth over £15 billion in 2021-22, or 68% of the value of all reliefs against assets in estates over IHT thresholds.
“Any gifts you make to your spouse or civil partner in your lifetime or on your death are exempt from IHT, assuming they are also UK domiciled. Crucially though, this exemption doesn’t apply to gifts between unmarried partners, even if you have lived together for many years.
“Agricultural and business property relief (BPR) combined saved wealthy families from paying IHT on around £4.4bn of assets in 2021/22.
“BPR was worth £2.9 billion and used by 4,170 estates, making it the second most valuable of all the IHT reliefs. Full IHT relief can be available for the business assets of trading companies held for over two years before death. Land and machinery can benefit from a 50% reduction in taxable value, meaning family-owned businesses are not faced with the pressure of stopping trading or being sold to fund IHT bills. Shares in unquoted trading companies also qualify, along with shares on the UK AIM market, meaning the relief is available to private investors too. Reliefs available for agricultural property work in a similar way.
“There are also exemptions available for gifts to qualifying charities – something 9,780 estates made use of in 2021-22 to a value of £2.1 billion, up over 16% on the previous year.
“There are other gifts you can make in your lifetime that are exempt.
Annual gifts
“Anyone can gift up to £3,000 a year, either to one person or split between multiple people, without it being considered for inheritance tax purposes.
“You can also give unlimited gifts of up to £250 per person, if you haven’t used another allowance to make them a gift.
“You can also gift extra amounts to someone getting married or entering a civil partnership. These are up to £5,000 for a child, £2,500 to a grandchild or great-grandchild or £1,000 to anyone else.
“The effect of gifting is to remove money from your estate, meaning that you have less taxable assets on death.
Gifts from income
“You can make regular gifts from your income, and these will be tax-free, provided they don’t reduce your standard of living. Do make sure you keep good records of you regular income and these outgoings as whoever is taking care of your estate admin will need to declare them as part of any IHT return.
“If you want to make substantial gifts over these limits and allowances then you need to be aware of the seven- year rule. If you die within seven years of giving these gifts, IHT is due on a sliding scale known as taper relief.
“Trusts can be an effective way of Estate Planning, but the tax rules are complex. You should consider professional legal and financial advice if this is something you’re considering.”
