Inheritance tax affects more families as property values rise

Inheritance tax affects estates above the nil-rate value of £325,000. This allowance hasn’t changed since 2009, when the average house price in the UK was just over £157,000. In April 2023 the average house price was £286,500. So, today, someone with modest lifetime savings and other assets could easily exceed the IHT limit. This also affects their beneficiaries who might hope to use their inheritance to buy their own home. 

 

If someone who dies leaves their main home to their children or grandchildren there’s an extra £175,000 allowance. Married couples and civil partners can each pass on this additional allowance so they can jointly leave up to £1million before IHT applies. 

 

However, wealthier couples might not qualify for the full tax relief. If the value of their estate exceeds £2million the residence nil-rate band reduces. For every £2 over this threshold, the allowance goes down by £1 until it reaches zero. For many couples, the residence nil-rate allowance disappears once their estate exceeds £2.7million. This is becoming more common because the first spouse often leaves everything to their surviving partner. The whole estate is then left to their family. Beneficiaries could lose the whole nil-rate band allowance, meaning an additional £140,000 of IHT is payable. 

 

If house prices keep rising and IHT thresholds don’t change almost 5,500 families could feel this affect each year by 2028. 

 

IHT doesn’t apply to pensions. Paying as much as possible into a pension can reduce the size of your estate. In the Spring Budget 2023 the Chancellor abolished the pension lifetime allowance, making extra pension contributions more attractive. However, there is still an annual tax free allowance for paying in to pensions. This increases from £40,000 to £60,000 in April. 

 

If a pension holder dies before their 75th birthday their beneficiaries inherit their pension pot tax-free. If they are over 75 their beneficiaries can receive their pension as income and pay their marginal income tax rate. If their income is below the higher income tax band of £50,271 they’ll pay 20% tax instead of 40% IHT. 

 

However, the limit for the tax-free lump sum taken is just under £270,000. If someone planned to use this lump sum for living costs for a while, for example, they might need to think about alternatives. 

 

Another option is to reduce the value of an estate by using the annual gift allowance each year and making charitable gifts.