- IHT thresholds will be subject to a freeze lasting more than two decades after Rachel Reeves fixed nil rate bands until April 2030 at inaugural Budget
- Figures show that by 2030 a couple could pass on £1.1 million tax free if the nil rate band alone had tracked inflation
- Almost £1.6 million could be left tax free if both nil rate band and residence nil rate bands were indexed to prices
- Increasing both limits with inflation could have spared families up to £234,000 in IHT bills
- Speaking to a financial adviser can help families beat IHT
A two-decade long freeze on the inheritance tax (IHT) allowance could cost families almost a quarter of a million pounds by the end of the end of the Chancellor’s tax threshold freeze, analysis from AJ Bell shows.
The main IHT exemption, the ‘nil rate band’, has been frozen at £325,000 since 2009. Amounting to £650,000 for a married couple, assets under this threshold incur no IHT. However, the limit last increased in 2009 and isn’t due to be lifted until April 2030, with Rachel Reeves extending the IHT threshold freeze at last week’s Budget.
Although a new exemption, the ‘residence nil rate band’ (RNRB), introduced from 2017 means a married couple can leave a combined total £1m tax free if they leave a property to their ‘direct descendants’, AJ Bell’s figures show that the overall IHT threshold would actually be higher had the main nil rate band simply been linked to inflation and the RNRB were never introduced.
The nil rate band indexed to inflation would stand at almost £555,000 by 2029/30, meaning a couple could pass on an additional £110,000 tax free. It means tax bills could be £44,000 higher per family as a result.
But if both the nil rate band and residence nil rate band were indexed to inflation the combined total would stand at nearly £1.6 million, knocking up to £234,000 off IHT bills.
IHT bill on £2m estate in 2029/30:
AJ Bell pensions and savings expert, Charlene Young, says:
“Frozen tax thresholds punish taxpayers by stealth. When asset prices rise but thresholds fail to track inflation, the result is higher tax bills.
“Astonishingly, the main IHT free threshold won’t have changed in over two decades by the time the freeze is lifted in 2030.
“Although a new exemption has been introduced since then – the residence nil rate band – these figures show it actually doesn’t compensate for frozen thresholds. Had government done nothing whatsoever other than index the IHT allowance to CPI over the last 20 years then the tax-free limit would be almost £1.1 million for a married couple in 2030.
“Families with an estate over this sum stand to pay an extra £44,000 in death duties as a result.
“Had both the nil rate band and the more recently introduced RNRB both been index linked by default then the total IHT-exempt threshold would be over £1.58 million. Were that the case it would shave £234,000 off IHT bills for some families.
“The tax bill on a £2 million estate will be £400,000 thanks to frozen thresholds. That would be reduced to £166,000 if the exemption for the combined assets of a married couple had been uprated.
“For larger estates over £2 million the story is even worse, since the RNRB is gradually tapered away for households with cash and assets to pass on above this level. This is likely to be exacerbated by the inclusion of unspent pensions within taxpayer’s estates from April 2027.
“HMRC’s own estimates show the taxman will be able to take a tax slice from 4,300 new estates thanks to the two-year extension on the freeze.”
How the IHT threshold would have looked without the two-decade freeze:
Source: AJ Bell. Nil rate band indexed in April based on previous September’s CPI. Residence nil rate band indexed from 2021. Future years use OBR forecast annual inflation. Based on a single person.
Three ways to start estate planning
“The government likes to tell us only 1 in 20 estates currently pays IHT, but their own figures show the amount they are raking in was already going up before the changes announced in the Budget.
“New rules (that are being consulted upon) for unspent pensions to get dragged into the IHT net from 2027, could result in higher bills for nearly 50,000 estates. That’s before the impact of an extra two-year freeze in thresholds will be felt.
So what can you do now if you think your estate might be affected? Here are just three tips to reduce the impact of IHT on your loved ones:
- Make a will
“If you die without a will, your estate will fall under the intestacy rules. This could mean a higher IHT bill and if you have no surviving relatives, the rules can even pass your wealth to the Crown. Unmarried partners do not have the same rights as those in a marriage or civil partnership - even when they have lived together for many years - and under the intestacy rules, they will not inherit from you. If you already have a will, it’s a good idea to review it and keep it up to date. You can use your will to detail your funeral wishes, and most funeral expenses are generally deductible from for IHT.
“If you have significant assets, estate planning using trusts can also help mitigate a tax bill. Trusts and taxation are complex areas, so you should seek professional advice from a solicitor and an independent financial adviser to avoid any costly mistakes.”
- Use annual exemptions and gifting allowances
“There are gifts you can give each tax year that are exempt from IHT and reduce the value of your estate. The ‘annual exemption’ lets you give away a total of £3,000 each year, either to one person or split between several others. You can also bring forward unused annual exemption for one year, Unlimited ‘small’ gifts of up to £250 per person can be made, if you haven’t already used your annual exemption on the same person.
“Tax-free gifts to someone getting married or entering a civil partnership are also available: up to £5,000 for a child, £2,500 to a grandchild or great-grandchild, or £1,000 to anyone else. These can be combined with other allowances but to meet the rules, a wedding gift must be made before the wedding itself, and the wedding must go ahead.
“Other gifts that are not exempt or within the allowances above are called potentially exempt transfers, meaning they only escape IHT if you survive for seven years after making them. If you die within seven years then the value of the gift is added back into your estate, but taper relief might reduce the rate of IHT on it if at least three whole years have passed.
“A powerful gifting allowance that is often missed is making gifts from excess income. You can set up regular gifts from your extra income without limit – for example to help towards grandchildren’s school fees or invest in their Junior ISA - provided you can show that they do not reduce your standard of living. The best way to evidence this is to keep records of your regular income and show that you’re not having to cut back on your normal spending to make them. The records will also be needed when it comes to administering your estate and claiming the exemption.
- Consider life insurance to pay the tax bill when you’re gone
“Depending on cost, you could find life insurance is a simple way to fund a likely IHT bill, or to cover large gifts made in the past seven years. You should also review any life insurance you already have, particularly anything you’ve got through your employer. That’s because the payouts from policies can count as part of the estate unless your policy is written in trust.
“Writing policies in trust removes them from your estate and means your loved ones don’t have to wait for probate to make a claim. As IHT must normally be paid within six months to avoid interest and needs to be settled before probate is granted, insurance could make things easier for your loved ones and prevent assets having to be sold to help pay any bill.”
Autumn Budget 2024:
How the IHT threshold increased before the freeze:
Source: HMRC
