If you are worried about the effects Inheritance Tax (IHT) could have on your loved ones upon your death, you’re not alone.
Indeed, research carried out by Canada Life revealed that 40% of people are concerned about paying IHT, with a fifth of surveyed consumers taking some level of action to mitigate a potential IHT bill in the future.
However, there are plenty of myths surrounding IHT that are making it difficult for UK adults to truly know how this levy works and whether they will be liable.
So, read on to understand exactly how IHT could affect you and your loved ones, and discover six of the most common IHT myths and why they aren’t as relevant as you might think.
Your estate could be liable for IHT
IHT is a potential tax on the value of your estate, including property, possessions, and money when you die. The current standard IHT rate is 40%, which means you could be charged on the part of your estate that is above the nil-rate band (NRB) of £325,000 (in the 2023/24 tax year).
Additionally, the residence nil-rate band (RNRB) introduced in April 2017 enables you to gain further IHT relief of up to £175,000 if you leave your home to a child or grandchild.
So, if you own your home and you want to pass it to your children or grandchildren, you can utilise the residence nil-rate band in addition to your normal nil-rate band. This means that no IHT will be due if the total value of your estate is below £500,000.
Additionally, civil partners and spouses can also pass over unused allowances, so an individual can, in theory, leave up to £1 million before IHT is due.
Considering recent freezes to the nil-rate bands, and strong property price rises and asset growth over recent years, it’s now much more likely that your estate will exceed the nil-rate bands when you die. Indeed, a report by FTAdviser revealed that IHT receipts rose by £1 billion between April 2022 and March 2023, compared to the same period the year before.
If you’re looking to mitigate the effects that IHT could have on your estate, it’s important to have all the right information to hand. So, identifying why some of the myths surrounding IHT could help you better plan for the future.
1. “The government makes a lot of money from IHT”
IHT is seen as one of the most unpopular taxes among Brits, with a report by This Is Money suggesting that 1 in 4 UK adults consider IHT their least favourite tax.
Despite that, the overall sum of money that IHT generates for the Treasury is relatively small compared to other tax levies. For example, in 2022, IHT raised £6.4 billion, less than alcohol duty and tobacco duty, which raised £12 billion and £9 billion respectively.
While there has been an increase in IHT receipts in recent years, in comparison to other taxes like Income Tax, National Insurance, Capital Gains Tax (CGT), Corporation Tax and VAT, IHT does not currently raise significant funds for the government.
2. “A property can be gifted, meaning no tax will be payable”
While leaving your home to loved ones seems like a logical way of minimising any IHT payable on your death, it isn’t as straightforward as that.
It is often perceived that if you give away your home more than seven years before your death, the property will no longer be part of your estate and no IHT will be payable. While this is partially true, there are some considerations that you need to make.
For example, if you gift your home to your children but carry on living there, this will likely be deemed to be a “gift with reservation”, as you will have transferred the asset but not actually given up your use of it. Consequently, the property will likely still be considered part of your estate for IHT purposes.
For it to be a true gift, you will normally have to pay a market rent while living in the property.
Additionally, if you gift your house to loved ones but die within seven years of making the gift, the value of your gift will usually be added into your IHT calculation.
It is also worth noting that if you gift your home to one of your children and they later get divorced, the property may form part of the divorce settlement. Similarly, if your child is made bankrupt, the property may have to be sold to pay off their debts.
Other taxes may also apply to a gift of property, such as Stamp Duty Land Tax and CGT, so seeking professional financial advice would be advisable.
3. “Assets abroad do not count for UK IHT”
If you live in and are domiciled in the UK, your entire estate across the world is potentially subject to IHT after your death, no matter where your assets are situated.
This can include foreign bank accounts, holiday homes, and foreign investments. While there is a liability to death duties in other countries, that doesn’t mean that you wouldn’t have any liability to UK tax, although normally there is a “pecking order” between countries.
For instance, if there is a liability to tax in Spain on a holiday home located there, you would be given some credit for the Spanish tax paid, so that you won’t pay tax twice. It’s also important to be aware that the rules are different for individuals not domiciled in the UK.
4. “Only the wealthy pay IHT”
In the tax year 2019/2020, 3.76% of UK deaths resulted in an IHT charge.
However, you may still end up facing an IHT bill without knowing it. As of April 2023, the average house price in the UK was £286,000, although for some areas this figure was significantly higher. These house prices mean that IHT could apply to those who are merely well-off, rather than just the very wealthy.
As property values have generally increased over the past few decades, many people who purchased their homes 30 years ago could now find that their assets exceed their IHT allowances.
5. “IHT only applies to property”
There is often a belief that IHT can only apply to property, and while a house may make up a large portion of the total tax liability, almost every asset within an estate could be liable.
In fact, IHT could apply to any available asset, including buildings, land, money on deposit, jewellery, shares in companies, cars, and art, for example.
It’s worth noting that your pension pots are typically not subject to IHT when you die and can therefore be a tax-efficient way of passing on wealth.
If you die before the age of 75, the person(s) inheriting your pension pot can inherit your pension without paying any Income Tax. If you die over the age of 75, the recipient will normally pay Income Tax on the inherited pension at their marginal rate.
While there can be several tax reliefs that can apply to other classes of assets, like business and agricultural assets, their conditions can be very strict. Although they can be valuable in reducing exposure to IHT, it could be worth checking them carefully to determine if they can be relied upon.
6. “Everyone will pay some form of IHT”
While there are many myths surrounding IHT, one of the biggest is that everyone will pay some form of it during their lifetime. However, only a small percentage of estates will likely to have to pay it.
Having said that, most estates will have to prove to HMRC that there is no IHT to pay before the distribution of assets can begin.
Additionally, the rate of tax paid is often lower among larger estates than it is among smaller ones. HMRC data reveals that estates worth £10 million or more paid an average of 10% in tax between 2015 and 2016, half the average 20% tax paid by estates worth between £2 and £3 million.
The reality of the situation is that very few people actually pay IHT – although the increasing numbers of estates facing a bill mean it should be a key consideration of your estate plan.
Get in touch
If you’re planning for the future and want to know how you can mitigate your IHT liability, speak to us. Please email admin@stonegatewealth.co.uk or call 01785 876222.
Please note
The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
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