Inheritance Tax (IHT) has become a prominent and widely debated issue following significant reforms introduced in the Autumn Budget 2024. Contributing £7 billion annually to the Treasury, IHT revenues are forecast by the Institute of Fiscal Studies to more than double to £15 billion by 2032.
The Autumn Budget 2024 introduced several consequential changes. These included introducing IHT charges on unused pension pots from April 2027, further freezes to the nil-rate band fixed to £325,000 until 2030 and abolishing the Non-Domiciled Tax Regime from April 2025. In addition, the Chancellor, Rachel Reeves, announced changes to Business Property Relief (BPR) and Agricultural Property Relief (APR), subject to a £1m cap on 100% relief for the first time. Critics have expressed fears that this could impact generational farming and disrupt the stability of rural economies.
While the perception is that IHT is only a concern for the ultra-wealthy, the aforementioned inclusions of IHT-liable assets, combined with freezes in the nil-rate band, will make a larger proportion of middle-income estates liable for IHT charges.
This article will help guide you on the principles of Inheritance Tax, explaining the key rates, allowances and reliefs available to enable you to reduce your IHT liabilities.
Or alternatively, our expert advisors specialise in guiding individuals and families through bespoke estate and financial planning strategies designed to mitigate IHT liabilities and protect wealth.
Get in touch to see how we can help you optimise your tax position and mitigate your IHT liabilities.
What is Inheritance Tax (IHT)?
Inheritance Tax is a levy (Tax) placed on the value of an estate that is payable when a person passes away. The estate includes a variety of assets such as property, savings, and significant personal possessions, and it is only applied after accounting for specific allowances and exemptions.
These exceptions can include administrative fees in tying up the estate and funeral costs. Any remaining taxable estates may incur the IHT standard rate of 40%.
The estate IHT liability must be settled for beneficiaries to tie up the estate and take full ownership of inherited assets. This often means that executors must liquidate assets or use other financial arrangements to ensure the tax owed is paid.
How Much is Inheritance Tax?
The standard rate of IHT is 40%, but this rate only applies to the portion of an estate exceeding the available tax-free thresholds. This tax-free threshold, known as the Nil Rate Band (NRB), is set at £325,000 and has been frozen until 2030 under the Autumn Budget 2024, having been set since 2009/10.
In addition to the NRB allowance, estates that include a primary residence inherited by direct descendants (children or grandchildren) include an additional threshold of £175,000, called the Residence Nil-Rate Band (RNRB).
This means that 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.
A reduced IHT rate of 36% is available if at least 10% of the net estate is donated to a registered charity. This provision incentivises charitable giving while lowering tax liabilities. Learn more about tax-efficient estate planning and charitable giving.
It is important to note that estates left to a husband or wife qualify for 100% spouse exemption, as their estate is legally considered ‘as one’ or dual ownership.
What Counts Towards Your Estate?
An estate encompasses all assets owned by the deceased at the time of death. These assets include:
- Property: Residential or commercial properties owned outright or jointly.
- Pensions: From April 2027, any unspent personal pension pots will be liable for IHT. This excludes state pensions.
- Savings and Investments: Bank accounts, stocks, bonds, and other financial instruments.
- Business: The value of business once BPR and APR allowances are considered.
- Personal Possessions: Jewellery, vehicles, collectables, and other tangible items of significant value.
- Life Insurance Payouts: If not written in trust, these payouts may form part of the taxable estate.
How Assets Are Valued for IHT
HMRC requires all assets to be valued at their open market value, which is the price they might reasonably fetch if sold.
Assets such as property can include valuations from multiple estate agents to provide a realistic market value. Unique or high-value items, such as artwork, require specific professional valuations and are strongly recommended to ensure compliance. Mistakes in valuation can lead to penalties or disputes with HMRC.
Any debts attached to the deceased estate, including loans and mortgages, must be settled and accounted for before the estate’s total value is considered for IHT. Assets that have been transferred prior to death but fall within the 7-year transfer period will be valued on a reducing valuation, taking the time that has passed into account.
Nil Rate Band (NRB)
The Nil Rate Band (NRB) is the standard threshold below which no IHT is payable. The NRB is set at £325,000 and is frozen until 2030 under the Autumn Budget 2024, having been set since 2009/10.
Transferable Nil Rate Band
One of the most advantageous aspects of the NRB is its transferability. If the full £325,000 threshold is unused upon one spouse’s or civil partner’s death, the unused portion can be transferred to the surviving partner. This effectively doubles the IHT-free allowance for the second estate to £650,000.
Residence Nil Rate Band (RNRB)
Introduced in April 2017, the Residence Nil Rate Band (RNRB) was implemented to address the impact of rising property prices. Individuals who pass their primary residence to direct descendants (children or grandchildren) are given an additional allowance of £175,000.
What are the Qualifying Conditions for RBRB?
To qualify for the RNRB, the following conditions must be met:
- The property must be inherited by direct descendants (For example, children or grandchildren).
- The deceased must have owned or co-owned the property.
- Estates valued over £2m will begin to see their RBRB reduced by £1 for every £2 over the threshold.
- The RNRB cannot be used against lifetime transfers made within 7 years of death.
This allowance is applied on top of the standard Nil Rate Band (NRB) of £325,000, potentially allowing a couple to pass on up to £1 million tax-free if both allowances are fully utilised.
Transferring the RBRB
Similar to the NRB, the RNRB is transferable between spouses or civil partners. Unused portions can be passed to the surviving partner’s estate, potentially increasing their total IHT-free allowance.
What is Downsizing Tax Relief?
The government recognises that many individuals choose to move to smaller, more manageable properties as they age. Downsizing tax relief allows individuals who sell or downsize their home to retain the benefits of the RNRB, provided certain conditions are met.
Downsizing tax relief, therefore, ensures that elderly residents are not financially obliged for IHT purposes to retain larger homes that they would otherwise struggle to maintain. The relief also applies where the deceased has sold their residence or otherwise ceased to own a residence, having moved into a residential home or living with a relative.
Eligibility Criteria for Downsizing Relief
- An individual must have sold, gifted or downsized to a less valuable home on or after 8th July 2015.
- The home must have qualified for the Residence Nil Rate Band (RNRB) if the person had kept it until their death.
- Direct descendants must inherit at least some of the estate.
Tapering for Larger Estates
The Residence Nil Rate Band (RNRB) taper threshold sets a limit beyond which the additional RNRB allowance begins to reduce. As of 2024/25, this taper threshold is set at £2 million. For estates exceeding this value, the RNRB is reduced by £1 for every £2 above the threshold.
For example:
- An estate valued at £2.3 million would lose £150,000 of the RNRB, leaving only £25,000 available.
- If the estate exceeds £2.35 million, the RNRB is eliminated.
The tapering mechanism means that larger estates may lose the benefit of the RNRB altogether, potentially resulting in higher inheritance tax liabilities. This makes estate planning essential for individuals whose estates are approaching or exceeding the £2 million threshold.
Proper estate structuring, such as making lifetime gifts or establishing trusts, can help reduce an estate’s value below the taper threshold, preserving the RNRB.
For further information about using Trusts for IHT, read our article: Can a Trust Help Reduce Inheritance Tax?
The 60% Marginal Rate Effect
The “60% marginal rate effect” refers to a tax anomaly that occurs due to the tapering of the RNRB personal allowance. When an estate value crosses the RNRB threshold of £2 million, the personal allowance of the deceased reduces by £1 for every £2 past the threshold.
For example:
For an individual with an estate valued at £2m, this would result in a total IHT liability of 40% on the remaining £1.5m (allowing for £325,000 NRB and £175,000 RNRB) for an IHT cost of £600,000.
If that same estate were valued at £2.35m, the RNRB allowance would be eliminated. Resulting in an estate value for IHT of £2.025m (allowing for £325,000 NRB), with an IHT cost of £810,00.
Despite an original estate valuation of £350,000 higher, the estate has now incurred an additional £210,000 in IHT charges. The combined effect of tapering and inheritance tax has resulted in a marginal tax rate of 60%.
This phenomenon highlights the importance of strategic estate planning, particularly for individuals with estates nearing the taper threshold.
Effective planning, such as lifetime gifting or the use of tax-efficient vehicles, can mitigate this impact. For guidance on navigating the complexities of inheritance tax, so get in touch.
Inheritance Tax Advice From Specialist Accountants
Inheritance Tax planning is vital to protecting your wealth and ensuring that your assets are secured to benefit future generations.
By understanding the thresholds, allowances, and reliefs available, you can significantly reduce the impact of IHT on your estate. From utilising the Nil Rate Band and Residence Nil Rate Band to exploring reliefs like BPR and APR, effective planning is both achievable and rewarding.
We are committed to providing tailored advice that aligns with your goals. Contact us today to create an estate plan that safeguards your family’s financial future.