Government inheritance tax (IHT) receipts are on course to be around 40% higher than just three years ago following the first seven months of official data for the current tax year.
October’s receipts of £776m are two thirds higher than the same month in 2021 and annual receipts are set to smash through the £8bn level this tax year to about £8.5bn. This follows previous record setting years in the 2021/22, 2022/23 and 2023/24 years of £6.1bn, £7.1bn and £7.5bn respectively.
Receipts are on the rise thanks to the continuation of ‘fiscal drag’, the freezing of the IHT nil rate bands at the same time as asset prices inflate. The bands have been static since 2020/21 tax year but in the meantime prices and property values have soared.
IHT is usually paid at 40% on the value of your estate over the £325,000 allowance, and there’s an additional allowance of up to £175,000 if you pass on your family home to children or grandchildren. If you’re married or in a civil partnership, you can combine your allowances and transfer assets between each other free of the tax – resulting in a potential £1m overall tax-free threshold per couple.
Going forward, the effect of fiscal drag is set to continue with the bands frozen for even longer until 2030. Yet measures announced in the Budget mean the death tax take is set to balloon in an unprecedented fashion in future years, swelling the government coffers significantly.
Draft rules bring inherited pension pots into the net for the first time from 2027 and apply a cap to agricultural and business reliefs relief from 2026. This could double the number of estates paying the tax and dramatically increase the burden for those already set to pay it.
What does it mean for financial planning?
The inheritance tax net is closing from several different directions simultaneously. The resulting more restrictive landscape with far fewer IHT reliefs and exemptions means early and well-executed financial planning will be essential to mitigate the impact.
While pensions continue to have the benefits of lifetime tax efficiency (25% tax free cash and tax-free investments returns), they are set to become unattractive as an estate planning tool in many circumstances. Accelerated withdrawal from pension pots to fund gifts could be more beneficial from an IHT planning perspective, but overall tax efficiency from an income tax perspective will also be a factor.
Meanwhile, earlier planning and extra thought around the use of gifting allowances and lifetime transfers have become more relevant.
Overall, it highlights the need for financial plans to be adaptable to the prevailing conditions. For some, the changes to the IHT regime will mean the need to rethink existing strategies before they take effect. For others, it’s a case of having to make specific IHT plans for the first time.
