The prime minister and chancellor are reportedly considering changes to inheritance tax as part of the upcoming Budget on October 30, according to the BBC.
While the details of these potential changes are still unclear, they could mean more people paying inheritance tax, or adjustments to how much is owed.
As discussions continue, it’s worth understanding how inheritance tax works, who pays it, and what exemptions or allowances are currently in place.
What is Inheritance Tax?
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Inheritance tax is a tax charged on the estate—property, possessions, and money—of someone who has passed away. It only applies to the value of the estate that exceeds a certain threshold, currently set at £325,000. The tax is levied at a rate of 40% on the portion of the estate above this threshold.
For example, if an estate is valued at £335,000, inheritance tax would only apply to the £10,000 above the threshold.
Exemptions and Allowances
There are several exemptions and allowances that can reduce or eliminate the need to pay inheritance tax:
- Estates below £325,000 are not subject to inheritance tax.
- Spouses and civil partners can inherit an estate free of tax.
- Estates left to certain charities or community sports clubs are also exempt.
- Agricultural land used for crops or livestock may qualify for tax relief.
In addition, if someone leaves their home to their children or grandchildren, the tax-free threshold increases to £500,000. Married or civil partners can also transfer their unused inheritance tax allowance to their surviving partner, effectively doubling the threshold to £1 million for families leaving property to their children or grandchildren.
Who Pays Inheritance Tax?
Despite its visibility, fewer than one in 20 estates—about 4%—actually pay inheritance tax. That equates to around 27,800 estates per year. However, experts at the Institute for Fiscal Studies predict that, under current rules, about 7% of estates could be subject to inheritance tax by 2032.
Interestingly, a 2023 YouGov poll suggested that a third of people believe they will need to pay inheritance tax, even though far fewer estates are actually liable for it.
Gifting Money to Avoid Inheritance Tax
Many people wonder if they can reduce their inheritance tax liability by gifting money to their children or loved ones before they pass away. The rules do allow for this, but with limitations:
- Annual exemption: You can give away up to £3,000 a year tax-free. If you don’t use this exemption one year, you can carry it forward to the next, allowing a maximum of £6,000.
- Income-based gifts: Gifts made from your income, rather than savings, may also be exempt from tax.
- Larger gifts: If you give away more than the annual exemption and pass away within seven years, the gift could still be subject to inheritance tax.
It’s thought that changes to these gift exemptions may be on the table in the upcoming Budget.
Using Trusts
Some families use trusts to pass on assets to their children in a way that may reduce inheritance tax. By placing assets into a trust, they are no longer considered part of the estate. However, the rules surrounding trusts can be complex, so it’s often a good idea to seek independent advice before setting one up.
How Much Does Inheritance Tax Raise?
Currently, inheritance tax generates around £7 billion in revenue for the UK government each year. With possible changes being discussed, this figure could increase if more estates become subject to tax or if exemptions are adjusted.
Potential Changes in the October 30 Budget
While we don’t yet know exactly what changes may be included in the Budget, it’s possible the government will look at revising gift exemptions, adjusting thresholds, or modifying other inheritance tax rules to raise more revenue.
If you’re concerned about how these changes might affect you, now is a good time to review your estate planning and consult with a financial advisor.
Final Thoughts
Inheritance tax is a significant financial consideration for some families, but with careful planning and awareness of the rules, there are many ways to reduce or eliminate its impact.
As we wait to see what changes might be introduced in the upcoming Budget, understanding how inheritance tax works and keeping an eye on potential reforms can help ensure you make informed decisions for your estate.
