Chancellor Rachel Reeves may have made a point of sounding upbeat in her maiden Party conference speech as chancellor this week, but for those worried about an upcoming tax raid in the Oct. 30 Budget, there was little to be cheerful about.
While the Labour Party has pledged not to raise the headline rates of income tax, national insurance or VAT, everything else appears to be fair game. Capital gains tax (CGT) is one such example, but another is inheritance tax, or IHT.
What is IHT? And What Isn't IHT?
Long considered Britain's "most-hated" tax because it carves out a government share of a deceased individual's estate—and is therefore a tax on assets that have possibly already been taxed during that person's lifetime—IHT is hugely unpopular because it creates large tax bills at a difficult time for grieving families.
There is a also very short grace period in which to establish probate, settle estates, and pay any relevant bills to HM Revenue & Customs (HMRC). Little wonder it is loathed.
IHT is, however, subject to several misconceptions. Chief of these is that the government takes a slice of whatever is left in your accounts, and that HMRC itself takes a slice of the proceeds from the sale of any property originally included in an estate.
This isn't the case for the majority of people, as less than 5% of estates end up paying IHT.
As such, the last HMRC figures from April to July 2024 show IHT receipts were £2.1 billion, so a rough extrapolation makes this less than £10 billion for each financial year. In this case that was a record for a three-month period, but it's small change compared to the near-£200 billion required to fund the NHS in the 2024-2025 tax year.
Are There IHT Allowances and Exemptions?
You get a per-person allowance called the nil-rate band, which is £325,000, which renders estates valued below that amount exempt. As of 2017, there's also a residential nil-rate band that takes a couple's allowance to just under £1 million, so most estates are not subject to IHT if the parental home is passed to children or grandchildren.
So What's the Actual IHT Tax Rate Then?
The IHT rate is fixed at 40%, which aligns it indirectly to the higher-rate income tax band in England and Wales. There's no tapering, so it's a 40% blanket charge on estates above the nil-rate bands. An estate is per individual rather than say, a married couple. A partner of a deceased person "inherits" the nil-rate band—so it's not lost on their death. This means the surviving partner doesn't have to move out of the family home to pay the IHT bill.
Has Any Allowance Been Made for Rising House Prices?
Brought in during 2017, the residential nil-rate band was a gesture towards house price growth. But the £325,000 nil-rate band hasn't changed since 2009, and since then average house prices have exploded: from £149,000 to £265,000. Regionally, these figures are even higher than the average: in the "outer" south-east of England the average home costs £332,000 and in London it will set you back £525,000. In southern England, it's already clear the average house costs way more than the single nil-rate band.
Politically this is a tricky balance: increase the band and you appear to be favoring home-owning Middle England voters, who tend to lean towards voting Conservative. The new government will be less concerned about upsetting this voting bloc, though. Just look at its approach to winter fuel payments. Remember: asset prices, including equities and funds, have also risen since 2009, so these can trigger IHT liabilities too.
How Many People Pay IHT?
Only a minority of estates (around 30,000) will incur an IHT liability, but that number is rising. 30,000 is about 4% of estates, but the number of liable estates is at the highest level since 2016/2017, when the new bands were introduced. Working taxpayers are also subject to "fiscal drag" because rising wages mean more people are dragged into paying more tax even when income tax bands are, officially at least, "frozen." Reeves' predecessor Jeremy Hunt froze the income tax bands until 2027-28, but that was a revenue-positive measure.
What this means is a government keen to raise more from IHT could just keep the status quo. Changes to tax bands like CGT and IHT often raise less money than governments want, argues James Smith, UK economist at ING, so why not just let fiscal drag do the work?
What Could Change in October's Budget?
IHT is still subject to a lot of press speculation because the government's plans aren't yet clear. This is where the dynamic is different to the CGT debate, where rates are considered "too generous" by some in the Treasury and lobbyists, who want the wealthiest to pay more.
With IHT, on the other hand, there's an assumption that the 40% rate is tough enough as it is, so there's less chance of a big headline increase. Again: fiscal drag means IHT is effectively rising every year anyway.
The following are, however, rumored to be vulnerable:
• IHT exemptions for AIM shares
• Exemptions for pensions
• The "seven-year rule" for gifts
• agricultural property relief and business property relief
In order, then: at the moment, holding shares for two years in alternative investment market (AIM) companies that also qualify for business property relief, which you have also not sold at the point of death, renders them exempt from IHT.
Likewise, though there are plenty of instances in which private pension holdings do not incur IHT—like pension scheme contributions—these rules could be made stricter.
Finally, the "seven-year rule" means that no IHT is due on cash gifts—provided your generous benefactor doesn't die in the seven years after the gift is given.
On pensions specifically, this type of savings vehicle has tended to have an advantage over ISAs in that they usually escape IHT. But that could now change. AJ Bell pensions and public policy expert Tom Selby says many view the system as low-hanging fruit.
"The tax treatment of pensions on death will be viewed by many as low hanging tax fruit ready to be picked," he says. "This is undoubtedly a generous set of rules and something that could easily be reviewed by the new government."
For those who have planned their finances on the assumption their pensions will escape IHT, this could be an onerous shift. There could be a transition regime, he says, to allow people to plan, but that would still be a blow for the pensions industry, which now struggles to compete with the simplicity and ease of access offered by other savings vehicles.
How Can I Avoid Paying IHT?
It's best to seek professional and regulated financial advice because the rules around gifts, trusts, and charity donations are changing all the time; plus HMRC is wise to any sleight of hand by wealthy families to avoid and even evade IHT itself.
CGT changes are easier to "front run" because asset owners can dispose of property and shares ahead of the point at which new Budget policies are implemented. There's some evidence this is already happening. From a timing point of view, it's much harder to get ahead of IHT changes because you don't know when an IHT exposure will be triggered. If there are substantial changes, the nature of financial advice around minimizing IHT exposure is likely to change too.
Is This The First Time Gov't Has Mulled IHT Reform?
IHT is always in the crosshairs of Treasury mandarins. But so to is it in the sights of cross-Party working groups.
Back in 2020, the All-Party Parliamentary Group (APPG) on Inheritance and Intergenerational Fairness proposed slashing the IHT rate to 10%. This recognized that, for many people and partly because of rampant house price inflation, buying a house is only possible when their parent(s) die. Its idea was to reduce the impact on future generations, who are more dependent on inheritance to get on the property ladder.
Today, that particular proposal feels like a long shot. The chancellor has already signalled she is in "take" mode, and there is a collosal list of policies and problems that need paying for and fixing. When political parties were warming up last year for 2024's election campaign, there was some talk from the Tories that IHT could be scrapped altogether, but not even that was enough to save Rishi Sunak in the polls.
No doubt the idea will return. It's just a question of when—and who.
