With less than one in 20 estates liable for inheritance tax, possible tax hikes at the Budget are still creating anxiety, so how can you avoid them

There have been rumours that inheritance tax could be tweaked in the Budget, but no detail will be available before the big day on 30 October.

In the first four months of the new tax year, estates paid £2.8bn in inheritance tax (IHT), £200m more than the same period last year, so there is potential for the Chancellor to tweak the rules and collect an extra billion or so in taxes.

 

Potential changes could include an increase in the IHT rate from the current base rate of 40% to up to 50%, for example, or a more controversial overhaul of nil rate bands, changes to business property relief and agricultural property relief, and charging capital gains tax on assets at death. Another option would be to make pensions subject to IHT as beneficiaries can collect outstanding pension pots tax free.

 

Inheritance tax casts a long shadow. Fewer than 28,000 estates paid it in 2021/22 – that’s less than 4.5% of the 634,000 estates that were passed on that year. And yet millions of people are worried about the impact this tax could have on their family.

 

Rumours of potential changes in the Budget in October have fuelled more inheritance tax anxiety. Even those who fall well short of the current thresholds are worrying that tweaks to this tax could mean HMRC takes a big chunk out of their estate after they die.

 

We can’t definitively state one way or the other what lies in store, but we can explore the options, assesses what’s likely, and identify the steps worth taking today to protect yourself.’

 

It is possible to take mitigating steps, but acknowledges that uncertainty is problematic. Here we look at setting out potential IHT changes and any mitigating actions to take.

 

The options

 

1. Increasing the inheritance tax rate from 40% to 45% or 50%

Likelihood: There are a handful of things that make this an outside chance.

• Fewer than one in 20 estates pay it, so it wouldn’t raise a vast amount of money.
• If you hit the wealthy hard, they’ll pay for expert help to cut their bill, so it could limit the gains even more.

 

2. Revisiting nil rate bands

 

These play a big part in protecting smaller estates. The first £325,000 of all your assets fall into the nil rate band, so you don’t pay tax on it. If your assets include a home that you’re giving away to children or grandchildren, you also get a £175,000 residence nil rate band, so you can give away property up to this value and pay no inheritance tax.

Likelihood: This can’t be ruled out but would be so controversial that it makes it less likely.

• It would affect more people and could cause a significant backlash.
• There are other allowances which would be far less controversial to change.

 

3. Reconsidering rules around spouses and married partners

Anything you leave to your spouse or civil partner is free of inheritance tax, and if you pass everything to them after your death, you also pass your nil rate bands. It means when the second person in a married couple dies, they can leave assets worth up to £1 million free of tax.

Likelihood: This could have a massively negative impact politically, so it’s unlikely to be at the top of the list.

• Paying tax on assets left to a spouse could mean endless stories of bereaved spouses forced out of their home by HMRC.
• Not being able to pass nil rate bands would mean a tax bill after the death of a couple living in an average property in London. It would magnify the number of people who are stressed about inheritance tax.
• There are far less controversial measures on the table.

 

4. Tweaking agricultural relief or business property relief

There are specific types of relief available to farmers and owners of family businesses (and investors in the alternative investment market) – worth £4.4 billion in 2021/22.

Likelihood: Change is more likely here. However, the government might choose to tweak these reliefs rather than axing them.

• It might apply agricultural relief to fewer assets and under more limited circumstances.
• However, a proper review of this relief and how it operates would be a sensible first step, to ensure changes wouldn’t cause irreversible damage to family farms.
• The government has the option of squeezing business property relief by limiting the assets it applies to, increasing the minimum holding period (possibly from two years to five years), capping the maximum or reducing the level of relief.
• However, this could affect investors in qualifying AIM companies, which are currently inheritance tax-free after two years. Tweaking this tax relief could cut vital investment for these companies. Retail investors are important funders of smaller listed businesses, because many institutional investors won’t focus on smaller stocks. Investors need an incentive to invest in smaller companies, where they are exposed to more risk. The government would need to seriously consider the implications for these companies if they were to cut the tax benefits of holding AIM stocks.

 

5. Making pensions subject to inheritance tax

Money in a defined contribution pension can be passed on free of inheritance tax.

Likelihood: Change isn’t beyond the realms of possibility, especially given the difference in how pensions are treated on death when compared to other invested assets.

• For those who plan to use their pension to buy an annuity, and for those with defined benefit pensions, there’s no change.
• For those who plan to spend their pension within their lifetime, there’s no impact. And given that so many people expect this to be the case for them, it could limit the reaction to any change.
• It will largely affect those with larger estates who don’t spend their pensions – either because they pass away earlier than expected or because they have used their pension to help cut their inheritance tax bill.

 

6. Charging capital gains tax on death

If you pass on investments outside an ISA or pension after your death, there’s no capital gains tax to pay – so it effectively resets to zero. The government might decide to charge CGT on death.

Likelihood: It’s not hugely unlikely, because the government might consider this relatively low-hanging fruit.

• Anyone who has invested in stocks and shares will still be able to realise their gains gradually over time and pay no tax on them – especially if the government reverses the cuts to the annual CGT allowance.
• They can also gradually move them into stocks and shares ISAs using the share exchange (Bed and ISA) process each year, so there’s no CGT to worry about in future.

 

How can you prepare?

 

If you’re worried the government might cut the nil rate band, you can give up to £3,000 away before the change, which will fall within your annual gift allowance. You can give away larger sums and they will be outside of your estate after seven years. There’s a separate rule that means you can give away surplus income inheritance-tax free too.

 

You need to pay it from your regular monthly income and have to be able to afford the payments after meeting your usual living costs. It’s also essential to keep good records of these gifts, and to check HMRC’s rules about how to do this.

 

If you have children in your life who are under the age of 18, you could consider paying £3,000 into a Junior ISA for them each year. This is counted as being given away immediately for inheritance tax purposes but is tied up until they reach the age of 18, at which point they can make sensible adult decisions with the money.

 

You can pay up to £9,000 into JISAs each year, but a portion of this would only fall out of your estate after seven years.

 

Giving gifts makes sense if you were planning to give this money away anyway, and you can afford to part with it. However, if you can’t afford it now, don’t let tax anxiety rush you into something you’ll regret.

 

If you’re investing in qualifying AIM companies, and plan to take advantage of the inheritance tax break, this isn’t necessarily a signal to sell. If the government removed the tax break entirely, it would mean bringing in retrospective taxation, and could seriously damage investment in smaller, listed businesses. It means it might consider alternatives, such as changing the qualifying period. If the investment is otherwise right for your portfolio, it doesn’t make sense to rush into a decision to sell.

 

If you’re worried about capital gains tax treatment on death, it’s a good idea to realise capital gains each year if you can and move as many assets as possible into stocks and shares ISAs during your lifetime, using the share exchange (Bed & ISA process).