Inheritance Tax: how it works, and what you can do about it

By Chancellor

Inheritance Tax (IHT) has been called “Britain’s most hated tax” by several newspapers, but often, media noise can drown out what you actually need to know about it.

Here at Chancellor, we are committed to being as transparent as possible about financial factors that could affect your family’s wealth.

So, keep reading to learn the basics of Inheritance Tax (without the media jargon that often goes with it), and find out how a financial adviser could help you mitigate it where possible.


Inheritance Tax is only due on assets that exceed the nil-rate bands

When a person passes away, their estate is usually passed to their beneficiaries, normally their spouse or children. If a spouse inherits the estate, no IHT is due at all.

However, if their assets are passed to the next generation (or anyone other than their spouse), this may attract IHT – but only if the value of their estate exceeds the “nil-rate bands”.

The nil-rate bands are brackets under which no IHT is usually paid. These bands are the same for everyone, unless your estate is worth more than £2 million, in which case the residence nil-rate band may be tapered.

As of the 2023/24 tax year, the nil-rate bands exist as follows:

  • The £325,000 nil-rate band covering all assets, including property
  • An additional £175,000 residence nil-rate band designed to account for property passed down to children or grandchildren.

So, if you were to pass away and leave your home and other assets to your children, they could potentially inherit up to £500,000 before paying any IHT.

Remember: IHT is an individual tax. So, you and your spouse, or the other parent of your children, could potentially leave a combined asset value of up to £1 million tax-efficiently.

At the time of writing, the nil-rate bands are set to be frozen at these levels until 2028, although this may be subject to change.


Once you pass away, your beneficiaries may pay Inheritance Tax out of what they receive from your estate

You could be wondering: “How is IHT actually paid?”

Usually, after a person passes away, their estate is handled as follows:

  • The executor of their will is tasked with valuing the estate, meaning they total up the deceased’s assets including properties, investments, trusts, and cash. Pensions do not usually form part of a person’s estate for IHT purposes.
  • They report the estate’s value to HMRC, even if they do not believe that any IHT will be due.
  • Once the executor knows how much IHT is due on the estate, it is up to the beneficiary (or beneficiaries) to organise payment. There is usually a six-month deadline on paying IHT bills, but there may be exceptions to this.

As of the 2023/24 tax year, the rate of IHT is usually set at 40%, although this can vary for assets in trust, and may also be tapered in some circumstances.

Having a relationship with a financial adviser could come in handy here; we can help you through any financial requirements after a loved one passes away.


Only a small percentage of families pay Inheritance Tax, but this may increase in the coming years

Many people believe that IHT is an inevitable tax, but as you read above, a person has to leave a substantial amount of wealth behind in order for it to be taxed.

In fact, according to the Institute for Fiscal Studies (IFS), fewer than 4% of estates paid IHT in the 2020/21 financial year. However, this research concluded that this could rise to more than 7% by 2032/33 due to the increasing wealth of older individuals in the UK – but even then, the findings show that only a small percentage of UK families are actually affected by IHT.

If your family could be one of the small number that pays IHT, it is important to be aware that IHT receipts are already increasing.

According to a report from FTAdviser, HMRC collected £3.9 billion in IHT between April and September 2023. This figure is £400 million higher than the same period in the previous year. And, as the IFS reports, annual receipts could rise to around £15 billion if takings keep increasing at their current rates.

One factor pushing IHT receipts up is that the nil-rate bands, while frozen from now until 2028, have been stagnant for some time already. According to HMRC, the £325,000 nil-rate band has not increased since 2009, and the residence nil-rate band has stood at £175,000 since April 2020.

So, even if your family may not pay IHT if you were to pass away now, the value of your assets could increase in the coming years, potentially pushing a portion of your wealth into the taxable bracket in future.


Your financial adviser could help you reduce your loved ones’ future Inheritance Tax bill

You and your loved ones may not need to worry about IHT at all – but if your estate is likely to attract this tax, your financial adviser can offer guidance on lowering your bill.

The task of mitigating IHT ideally starts earlier in life, and could be achieved through some of the following actions:

  • Giving a portion of your wealth to the next generation before you pass away. To ensure this move is tax-efficient where possible, it is important to begin planning your “giving while living” strategy as early in life as you can, with the help of a financial adviser.
  • Using investments and cash to partially fund your lifestyle in retirement, leaving your pension until last. This could help to reduce the value of your taxable estate because your pension does not usually attract IHT.

We’re here to discuss any IHT matters you have read about here, or to help you formulate a plan for reducing a future bill where possible.

Email, or call 01204 526 846 to speak to an adviser.

If you’re already a client here at Chancellor, contact your personal financial adviser to discuss any of the content you’ve read in this article.


Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

All contents are based on our understanding of HMRC legislation, which is subject to change.

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

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.