Why Inheritance Tax threshold freezes are actually a stealth tax on your wealth

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Inheritance Tax (IHT) is often regarded as Britain’s most hated tax. Charged at 40% as standard, the tax comes into effect at the worst possible time while families grieve a loved one, only to be served with a bill that can easily be in the tens or even hundreds of thousands of pounds.

Every individual does have a nil-rate band (NRB) before IHT is due, allowing you to pass on up to this amount to your chosen beneficiaries without them incurring a charge.

There is also an additional residence nil-rate band (RNRB) that you can apply for which you can make use of if you pass your main residence to your direct descendants, such as your children or grandchildren.

However, these two NRBs were both frozen until 2026 during prime minister Rishi Sunak’s tenure as chancellor in 2021. This decision has seen many more families squeezed into paying IHT when they might not have done so if the bands had risen over time, turning IHT into somewhat of a “stealth” tax.

So, read on to discover why this has happened, what it means, and methods you could use to reduce your estate’s IHT liability.

The nil-rate band has been fixed since 2009

In the 2022/23 tax year, the NRB stands at £325,000. This is the same level it has been fixed at since 2009, and where it will be frozen until 2026. As you can combine your allowances with your spouse or civil partner, that means you’d be able to pass on up to £650,000 without incurring a tax charge.

However, the government ordinarily regularly reviews tax bands like these, particularly in regard to keeping them in line with inflation. Otherwise, more people find themselves being pushed into paying tax as a result of the inflating value of their money.

Indeed, this certainly comes into focus even more when you consider that this year has seen inflation climb into double digits.

However, this hasn’t happened with the NRB and, under the current rules, won’t until at least 2026 either.

The threshold not rising with inflation is a significant issue. According to figures from accountancy firm Blick Rothenberg and reported in the Telegraph, the NRB should now be £462,330 today had it been adjusted for inflation over time.

This would translate as an additional £137,330 that you’d be able to pass on to your family without them having to pay tax, taking a couples’ total tax-free threshold to £924,660.

HMRC saw record IHT receipts in the first half of 2022

The major issue of the frozen NRB is that it’s seeing more and more families being squeezed into paying IHT, creating record tax receipts for HMRC.

According to FTAdviser, the Treasury received around £3.5 billion in the first half of 2022, the highest IHT take ever.

Without doing anything to mitigate your IHT liability, you are only more likely to be affected by this issue as inflation continues to surge while the NRB remains fixed.

3 quick ways to pay less IHT

Fortunately, there are various methods you can use to potentially mitigate the IHT bill your family will have to pay on your death.

Below are just three quick ways you could do so.

  1. Make full use of the allowance you have

First and foremost, you should ensure that you make the most of the allowance you have available.

Use your will to make it clear how your wealth is organised so that your executors can easily set aside the portion of your estate that’s IHT-free.

As you can combine your allowance with your spouse or civil partner, this means you can pass on up to £750,000 without your beneficiaries having to pay an IHT charge.

  1. Apply for the additional RNRB

If you own your home, you could be eligible for the RNRB, but you must claim this additional threshold to be able to make use of it.

In the 2022/23 tax year, the RNRB is £175,000, meaning a couple can pass on up to an additional £350,000, provided that their home is worth more than this value, and it goes to their direct descendants – that is, their children or grandchildren.

With the average house price in the UK sitting at £296,000 as of August 2022 when data was last available, this means it’s highly likely you’ll be able to use the RNRB if you own your home. So, make sure you claim this additional tax threshold – for example by making it clear who your home should pass to in your will – so that more of your money can go to those you choose.

Bear in mind that your RNRB will be reduced by £1 for every £2 that your estate exceeds £2 million in value. So, if your estate is worth £2.35 million or more, your RNRB will entirely taper away.

  1. Make use of all available gifting exemptions

Another option you have is to try and reduce the size of your estate by gifting your wealth during your lifetime.

There are many gifting exemptions you can use, all of which see your gifted money fall outside the value of your estate, including:

  • Annual exempt amount – allows you to pass on up to £3,000 each tax year, or £6,000 as a couple, with this value falling outside the value of your estate.
  • Smaller gifts – you can make unlimited smaller gifts of up to £250 to whoever you’d like, provided they did not receive money from you under any other gifting exemption.
  • Gifts from income – provided that the gift is regular and does not impede your ability to live your current lifestyle, you can make gifts directly from your income and have these amounts fall outside the value of your estate.

You can theoretically also make gifts of any size to anyone you’d like with the value falling outside your estate, provided that you outlive the gift by seven years or more.

If you die within the seven-year period, the gift will count towards your NRB. And, if it exceeds the threshold, you’ll be subject to a tapered rate of IHT, depending on how soon you died after you made the gift.

It’s often sensible to take professional advice before you make gifts to ensure that you meet the gifting criteria.

Get in touch

At BlueSKY, we can help you organise your wealth so that you only pay as much IHT as you have to.

Email info@blueskyifas.co.uk or call us on 01189 876655 to find out how we could help you.

Please note

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.

Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.

Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.