Inheritance Tax Rise in Budget? New Treasury Figures Illustrate It’s Already Rising by Stealth

As the UK government prepares for its upcoming budget announcement, discussions surrounding inheritance tax (IHT) are heating up. Recent Treasury figures reveal a significant increase in IHT receipts, raising questions about the future of this contentious tax. Between April and September of this year, inheritance tax receipts surged by £400 million compared to the same period last year, resulting in a record total of £4.3 billion for the Treasury. This article delves into the implications of these figures, the mechanics of inheritance tax, and potential changes on the horizon.

The Stealthy Rise of Inheritance Tax

The sharp increase in IHT receipts can be attributed to a critical factor: the freezing of the inheritance tax threshold. While inflation has driven up the value of estates, the threshold at which individuals begin to pay inheritance tax has remained stagnant at £325,000 since 2020. This freeze effectively means that more estates are falling into the taxable bracket, generating additional revenue for the government without any formal increase in tax rates.

Jonathan Halberda, a specialist financial adviser at Wesleyan Financial Services, pointed out that the government could maintain the current threshold and still see rising IHT receipts. "As we’ve already seen in the higher IHT receipts today, the government could simply leave the current £325,000 threshold unchanged, and IHT would continue to generate more cash for front-line services," he noted.

Understanding Inheritance Tax

Inheritance tax is levied on the value of an estate when someone passes away. Currently, there is no tax payable if the estate’s value is below the £325,000 threshold, or if the estate is left to a spouse, civil partner, or an exempt charity. For estates exceeding this threshold, a tax rate of 40% applies only to the portion above £325,000. For instance, if an estate is valued at £400,000, the taxable amount would be £75,000, resulting in a total tax liability of £30,000.

Couples can effectively double this threshold, allowing them to pass on up to £1 million without incurring any inheritance tax, thanks to the transfer of unused allowances between partners. Additionally, various exemptions exist, including those for agricultural land, family businesses, and pension pots.

Potential Changes to Inheritance Tax

As speculation mounts regarding potential changes to inheritance tax in the upcoming budget, several possibilities are being discussed. One notable consideration is the extension of the time frame for gifts to be exempt from IHT. Currently, individuals can gift large sums without incurring tax as long as they survive for seven years after the gift. Halberda suggests that the Chancellor may contemplate extending this period to ten years.

Other potential changes could include increasing the tax rate or lowering the threshold at which inheritance tax applies. There is also the possibility of revisiting exemptions, particularly those that benefit wealthier households, such as agricultural land and family businesses. Charlene Young, a pensions and savings expert at AJ Bell, noted that the Chancellor might consider reforming reliefs and the use of trusts, which are often utilized by affluent families. This could be framed as a tax on the wealthiest, potentially sparing the middle classes.

The Impact of Frozen Thresholds

Had the inheritance tax thresholds been adjusted for inflation since their freeze in 2020, a couple could currently pass on an estate worth nearly £1.5 million without incurring any tax. This stark contrast highlights the impact of the frozen thresholds on families and the increasing number of estates that are now subject to inheritance tax.

Despite its unpopularity, it is essential to recognize that inheritance tax affects a relatively small number of households. According to Young, only a tiny fraction of families ever pay IHT due to the available reliefs. Typically, a homeowning couple can pass on £1 million before the tax applies. For those with larger estates, various strategies exist to facilitate tax-efficient asset transfer.

Conclusion

As the government prepares to unveil its budget, the future of inheritance tax remains uncertain. While speculation about potential increases looms, the current figures illustrate that the tax is already rising by stealth due to the frozen threshold. With the implications of these changes affecting many families, it is crucial for individuals to stay informed and consider their options for estate planning. Whether through gifting, utilizing exemptions, or exploring trusts, there are strategies available to navigate the complexities of inheritance tax effectively. As the landscape evolves, understanding these dynamics will be essential for anyone looking to secure their financial legacy.