Why the number of families paying inheritance tax has almost doubled in a decade: Sarah Coles

This week’s figures showed that in June we paid more of this tax than in any month on record – at around £800 million. And given that it’s charged at 40% and the average IHT bill is £214,000, it’s worth exploring whether you might be at risk, and what you can do about it.

The rises in IHT have been enough to ring alarm bells for an awful lot of people. In the most recent tax year (2022/23) we paid £7.1 billion – more than double the amount we paid a decade earlier. In the first four months of the current tax year, we paid £2.6 billion, so if we carry on at this rate, we’ll end up paying £7.8 billion this tax year and will be on for another record year.

The rapid rise in IHT owes an awful lot to the fact that the inheritance tax thresholds – above which tax starts to be due - have been frozen. It means a combination of inflation, investment performance and house price rises have pushed thousands more people over the threshold. House prices may have fallen back slightly from the peak, but their growth is still phenomenal – up two thirds in ten years, adding almost £115,000 to the average property price in that time.

As a result, the number of families paying IHT has almost doubled in a decade, and in 2020/21 it hit 27,000. This is likely to have increased since then. In fact, as the result of the freeze in IHT thresholds, the OBR estimates 49,400 more families will pay IHT by 2028.

The all feels fairly ominous, but before anyone panics, it’s worth saying that most people won’t actually pay inheritance tax at all. In recent years only around 4% of estates have typically been subject to this tax. This is because most people’s estates are worth less than the thresholds. It therefore makes sense to start by working out what your estate will be worth, and getting to grips with the rules.

We all have a nil rate band – which is what we can leave behind before any tax is due – of £325,000. On top of this, if you own your home and plan to give it to children or grandchildren, you have the residence nil rate band of £175,000. Plus, if you’re married or in a civil partnership, you can leave as much as you like to them without paying any IHT at all. If you give everything to the surviving partner, you also give them your allowances, so the survivor may be able to leave an estate worth £1 million without owing any tax. However, if your estate is worth more than £2 million, your residence nil rate band will start tapering away, boosting your tax bill.

If you’re going to end up paying IHT, there are some things you can do to cut the bill - or wipe it out altogether. One of the most common is to give gifts during your lifetime. You have a gift allowance of £3,000 each year that falls out of your estate immediately for inheritance tax purposes. You can also give small gifts of up to £250, specific gifts for family weddings and unlimited regular gifts from income (which don’t eat into the capital). The gift allowances have been frozen for decades, but they’re still a useful way to cut your tax bill.

You can also make gifts of any size (known as potentially exempt transfers) and as long as you live for at least seven years after handing it over, it falls outside of your estate for inheritance tax purposes. This has the huge advantage of you being able to see your family enjoy their inheritance, and can make a significant difference to their quality of life. However, there are potential pitfalls to be aware of.

If you die within seven years, these gifts will be brought back into your estate and you may have to pay some tax on them. Meanwhile, if you live much longer you run the risk of having given money away that you need later in life. This can be an incredibly difficult balancing act, because none of us can know if we will eventually need to pay for expensive care or run up horrible property maintenance bills. We don’t know what’s going to happen to the cost of living either, and whether our income will keep up. It means we need to consider every eventuality when we make larger gifts.

Given that your home makes up such a large part of your estate it’s hardly surprising that so many people want to find a way to give it away before they die, and save tax. This is difficult though. If you try to give away your home before you die, but continue to live in it or benefit from it in any way, it won’t be counted as having been given away at all. So you’ll have paid for the legalities of swapping ownership without any benefit. Meanwhile, if you buy into a scheme that puts your home into a trust in an effort to avoid IHT, there’s no guarantee that these schemes will work, because the taxman may consider them to be tax avoidance. There are also significant costs to consider.

Some people will try to release equity from their home and spend the money or give it away in order to cut their IHT bill. However, you need to factor in the up-front costs and the ongoing interest. If you don’t live for seven years you could save far less than you expect (under the rules around potentially exempt transfers). If you live for much longer, you could end up spending more on equity release than you would have on IHT (because of the interest).

If you want to be absolutely certain you’re not leaving an IHT headache behind, then it may be worth taking out a life insurance policy to cover your tax liability. This should be written in trust, so it falls outside of your estate, and there’s no IHT to pay on it. This feels like yet another expense that will eat away at the legacy you can leave, but it means that if your family are presented with a bumper IHT bill after your death, it’s already taken care of.

Green Bond boost

NS&I has raised the rate on its three-year Green Bonds from 4.2% to 5.7%. It’s a decent offering, but for those keen to seek out the most competitive deals on the market, it falls short. It’s marginally less competitive than the previous issue – which was 0.25 percentage points lower than the top rate when it was launched. This time it’s very slightly further behind the leader - at 0.35 percentage points. It means you can do better elsewhere.

However, this rate may still be good enough for those savers looking to get a good deal for their money while contributing to green projects.

The timing could work in its favour too. At the moment, an easing of rate expectations means fixed term savings rates have stabilised, so anyone who has been holding off from fixing in case rates moved higher will be looking for opportunities. Meanwhile, we’re almost a year on from when we saw a rush to fix savings rates – from last September. Those who fixed for a year may well be looking for a new home for their money, so this is a useful time to stand out. Choosing this moment to offer a reasonably competitive rate puts it in the running for the wall of money set to hit the savings market in the coming weeks and months.

SARAH COLESHead of Personal Finance and Podcast Host for Switch Your Money OnHeadline Money Expert of the YearHargreaves Lansdown