Inheritance Tax (IHT) is one of the most misunderstood aspects of financial planning in the UK. With complex rules, numerous exemptions, and frequent changes to legislation, it can be overwhelming to fully understand the steps that need to be taken to minimise the impact of IHT on your estate. There are numerous myths and misconceptions about IHT, notably due to recent legislation changes, that could result in poor estate planning decisions, causing higher tax liabilities for your loved ones.
This article aims to debunk some of the most common myths surrounding inheritance tax, providing clarity and offering helpful guidance to minimise tax liabilities. Whether you are starting to prepare your estate for IHT or are concerned about recent legislation changes, understanding these myths could save you and your family significant amounts of money.
At DS Burge & Co, we aim to demystify inheritance tax and provide clear, accurate advice to help you prepare your estate in the most tax-efficient manner. Speak to one of DS Burge & Co’s inheritance tax advice specialists to take the correct steps to minimise your inheritance tax liabilities.
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Debunking Inheritance Tax Myths
Myth 1: Only the Wealthy Pay Inheritance Tax
One of the most common myths about inheritance tax is that it only affects the ultra-wealthy. In reality, a significant number of middle-class families could become liable for IHT as a result of freezes in the nil-rate band, combined with inflationary rises in property values and the inclusion of pension inheritance tax.
The current tax-free threshold, known as the Nil Rate Band (NRB), is set at £325,000. Estates that include a primary residence inherited by direct descendants (children or grandchildren) receive an additional threshold of £175,000, called the Residence Nil-Rate Band (RNRB). This means a typical estate will receive a tax threshold of £500,000 before IHT liabilities are applied. Once exemptions have been accounted for, any value that exceeds this threshold will be liable for 40% IHT taxation.
The Autumn Budget 2024 saw these IHT thresholds frozen until 2030, having been set at their current rate in 2009/10. With UK property values set to rise by 4% in 2025, compounding in a 23.4% rise by 2029, and the inclusion of pensions as part of your estate by April 2027, a larger proportion of estates will now exceed the tax-free inheritance tax threshold.
According to the Institute of Fiscal Studies (IFS), the proportion of estates liable for inheritance tax is set to rise by over 7% by 2032/33 from 4% in 2020/21, resulting in around one in eight people having inheritance tax due on their death or their spouses’ death. With the ongoing pressure on public finances and the continual upward trend in property values, these predicted figures could be considered conservative, with a larger proportion of middle-class families becoming liable for IHT than predicted. Inheritance tax is no longer an issue for the wealthiest in society. Individuals who fail to take proactive IHT mitigation become liable for the most significant charges.
For more information on how to navigate the nil-rate band and other exemptions, read our guide on how to avoid inheritance tax.
Myth 2: You Can Avoid Inheritance Tax by Gifting Assets Before Death
Another misconception is that gifting assets before death can altogether avoid inheritance tax. While gifting can be an effective strategy for reducing IHT liabilities, it is not as straightforward as many people believe. The seven-year rule applies to gifts, meaning that if the giver dies within seven years of making the gift, it may still be subject to IHT.
The value of the gift that forms part of the taxable estate is determined on a sliding scale, known as taper relief. Below is a breakdown of the tax payable on gifts that have not completed the seven-year transferable period, assuming nil-rate bands and any allowances have been exceeded:
| Years Passed | Taper Relief % | Tax Payable % |
|---|---|---|
| Less than 3 years | 0% | 40% |
| 3 to 4 years | 20% | 32% |
| 4 to 5 years | 40% | 24% |
| 5 to 6 years | 60% | 16% |
| 6 to 7 years | 80% | 8% |
| 7 years or more | 100% | 0% |
Some gifts are immediately exempt from IHT. These include annual gifts of up to £3,000 and unlimited small gifts of £250 per person within a tax year. You can additionally make tax-free wedding gifts to individuals getting married or entering a civil partnership. The allowances are dependent upon your relationship with the individuals and are as follows:
- Parents and Stepparents: Up to £5,000
- Grandparents: Up to £2,500
- Other Relatives and Friends: Up to £1,000
Gifting can be an effective way of minimising inheritance tax; however, it requires careful planning and consideration. It is important to ensure that gifting does not impact your ability to meet personal liabilities and stay within annual allowances, which can be used as an effective strategy.
If you want to learn more about using gifting, read our article on how to avoid inheritance tax.
Myth 3: You Always Pay 40% on Everything You Inherit
Some people believe that inheritance tax is a flat 40% rate applied to the entire estate. When an individual dies, the value of their estate is calculated, considering a range of assets, including property, investments, pensions and cash. Deductions can be made from the estate, including debts, funeral costs and professional services incurred in finalising the estate’s value.
Two main allowances are then taken into consideration: the Nil Rate Band (NRB), which is set at £325,000, and the Residence Nil-Rate Band (RNRB), which is set at £175,000. It is important to note that the RNRB only applies to the estate if it includes a primary residence and is inherited by direct descendants (children or grandchildren). This means that a typical estate has a total tax-free threshold of £500,000 before the 40% inheritance tax liability is applied.
For example, let us assume that an individual’s estate is £700,000 and includes a property valued at £300,000. Assuming the estate is inherited by direct descendants of the deceased, and taking into consideration the NRB and RNRB combined allowances of £500,000, the total estate liable for IHT would be £200,000. Given the 40% IHT rate, this would generate a liability of £80,000 on the estate.
It’s also worth noting that if at least 10% of the net estate is left to charity, the IHT rate on the remaining estate is reduced from 40% to 36%. This can be a valuable strategy for reducing IHT liabilities while supporting a good cause. Particular beneficiaries, such as spouses and civil partners, can inherit tax-free.
Myth 4: Spouses and Civil Partners Have to Pay Inheritance Tax
Transfers between spouses and civil partners are generally exempt from IHT, regardless of the estate’s value. When individuals marry or enter a civil partnership, their assets are legally combined and considered one. This means that when one partner dies, the surviving partner can inherit the entire estate without becoming liable for inheritance tax.
Any unused portion of the deceased’s nil-rate band can be transferred to the surviving partner, potentially doubling the tax-free NRB threshold to £650,000. This can be particularly beneficial for larger estates, potentially enabling the surviving partner to remain in the family property without fearing a significant IHT liability upon transfer.
It’s important to note that common-law partners (couples that live together) do not receive the same exemptions, so estate planning is crucial for unmarried couples. If you are in a long-term relationship but not married or in a civil partnership, it is worth seeking professional advice to ensure that you or your partner do not become liable for a significant IHT liability if either of you were to pass.
Speak to a DS Burge and Co inheritance tax advisor to proactively plan your estate if you are not married or in a civil partnership.
Myth 5: Trusts Completely Eliminate Inheritance Tax
Trusts are often considered a conclusive solution for avoiding inheritance tax and removing assets from the taxable estate. In reality, trusts can be a nuance, with multiple complexities and factors to consider.
While trusts can be an effective tool for IHT planning, they do not automatically remove assets from taxation. Some trusts face their own tax charges, such as periodic charges (every 10 years) and exit charges (when assets leave the trust). There are numerous trusts to consider, each presenting its unique benefits and drawbacks.
For example, discretionary trusts are subject to a 20% entry charge if the value of the assets transferred exceeds the nil-rate band. Additionally, a 6% periodic charge is applied every 10 years, and an exit charge may be levied when assets are distributed to beneficiaries. While a discretionary trust could minimise the full 40% inheritance tax, charges on death, entry, and periodic charges still present a significant tax. Trusts must be structured correctly to maximise their tax benefits while remaining fully compliant with regulations.
You can read DS Burge and Co’s article how trusts can help reduce inheritance tax for more information on this topic. However, if you are considering using a trust as part of your estate planning, seeking professional advice is highly recommended. Contact us for further guidance about using a trust to minimise your IHT liabilities.
Conclusion
Effective inheritance tax planning can be complex, with numerous legal avenues, such as gifts and trusts, combined with multiple thresholds and allowances. DS Burge and Co. has a range of information for you to explore inheritance tax further, including articles on how to avoid inheritance tax and can a trust help reduce inheritance tax.
By debunking these common IHT myths, we hope that we have provided you with a clearer understanding of how IHT works and how you can start to take steps to minimise your tax liabilities. With ever-changing legislation, the freezing of threshold allowances and the inclusion of pensions as part of an individual’s taxable estate, it is vital to take proactive steps today.
At DS Burge & Co, we specialise in helping clients navigate the complexities of inheritance tax. Whether you are planning your estate or dealing with an inheritance, our expert advisors can provide tailored advice to ensure your wealth is protected for future generations.
If you’re concerned about inheritance tax or need help with estate planning, contact our experts today. Our team is here to help you make informed decisions and safeguard your family’s financial future.