IHT, or inheritance tax, is what?

What is inheritance tax (IHT), who is responsible for paying it, and why are more families becoming taxed?

The government is raising record amounts from increasing numbers of families that fall into the inheritance tax (IHT) trap, but what is IHT?

The entire value of your assets over a specific threshold at the time of your death is subject to IHT. Due to frozen IHT thresholds, more estates are paying this so-called death tax as a result of rising asset values and high property prices, which caused the government to collect a record 8.2 billion in inheritance tax receipts in the 2024 - 2025 tax year.

This annual record sum was the fourth in a row. The most recent data from HM Revenue and Customs shows that the amount collected is 750 million, or 10 percent, more than the 7.5 billion total from the tax in 2023 - 2024.

The inheritance tax regime was altered by Rachel Reeves's first budget in October 2024, which most notably made pension pots subject to the tax. She also declared that until 2030, the 325,000 tax-free allowancealso referred to as the "nil-rate band"would remain frozen.

What is the inheritance tax, who is responsible for paying it, and how can the amount paid to the tax collector be decreased?

The inheritance tax (IHT): what is it?

When you die, your estate is subject to IHT. It is due on your assets, savings, investments, or business property. Additionally, gifts given within seven years of death may be subject to it.

Only when the value of your estate exceeds a specific threshold, referred to as the nil-rate band, is IHT charged at 40 percent. Thus, if your estate exceeds the IHT threshold by £100,000, the tax is due on the excess amount rather than the entire estate value.

But paying the right amount of IHT isn't always as easy as it seems. It's critical to comprehend the IHT thresholds and how to lower your tax obligation.

IHT thresholds: what are they?

Currently, 325,000 per person is the IHT threshold. Should your estate's worth surpass this threshold, the excess could be subject to a 40 percent tax.

You will receive a larger allowance if you leave your home to a direct descendant, such as a child or grandchild, but you can leave any amount tax-free to your spouse or civil partner.

If an estate is worth 500,000 and the nil-rate band is 325,000, for instance, IHT may be applied at a rate of 40% to the remaining 175,000. This leaves a £70,000 IHT bill. However, your spouse or civil partner wouldn't be responsible for this expense if you left them your estate.

Any unused nil-rate band can also be passed to your spouse or civil partnership upon your death, potentially doubling your combined IHT threshold to 650,000.

Additionally, you can use the residence nil-rate band if you leave your house to your children or grandchildren. Your IHT threshold rises to 500,000 as a result of this addition of 175,000.

When a married couple passes away, the combined IHT thresholds for them leaving their primary home to their children or grandchildren could reach up to £1 million on the second death.

Do pensions have to pay IHT?

Pension funds are not subject to inheritance tax at the moment. They can be transferred to beneficiaries free of IHT since they normally fall outside the estate when someone passes away.

However, starting on April 6, 2027, the government will transfer unused pension funds and death benefits payable from a pension into a person's estate for IHT purposes, the chancellor stated in her budget.

The announcement was "largely expected," according to Tom Stevenson, investment director at Fidelity International, because the pension pots' inheritance tax exemption "is something of an anomaly."

The move was dubbed a "blow for savers" by some experts, particularly because beneficiaries may have to pay both income tax and IHT on withdrawals if the pension saver passes away after the age of 75.

IHT is paid for by whom?

IHT is typically paid to HMRC by the will's executor. The person designated as the estate administrator will make the payment if there is no will in place at the time of death.

Typically, estate funds or proceeds from the sale of estate assets are used to pay IHT. According to the rules, payment must be made by the end of the sixth month following the deceased person's passing. HMRC will begin to charge interest if the tax is not paid within this window of time.

In most cases, the estate's beneficiaries won't get their inheritance until the IHT and any outstanding bills or expenses have been paid. In certain situations, though, beneficiaries might consent to pay IHT on their own if the estate does not have enough money to cover the tax obligation.

In the UK, approximately one out of every 25 deaths entails an IHT liability, according to investment platform AJ Bell. However, because the nil-rate band has been frozen until 2030 and pension pots are now subject to the tax, it is anticipated that the number of estates liable for this tax will rise in the upcoming years.

Ways to lower an inheritance tax liability.

There are multiple strategies to lower your IHT bill. These consist of:

Write a will.

In addition to helping to lower any IHT liability, creating a will guarantees that your assets are allocated to the people you designate after your death. You can make sure that you utilize all of your IHT reliefs and allowances. Intestacy laws apply to your estate if you don't have a will, so your loved ones might not receive what you desire and the tax collector might receive more than is required.

Contribute to a charity.

Your IHT rate may be lowered if you designate in your will at least 10% of your estate to charity. The 40 percent will drop to 36 percent after you receive a 4 percent discount. You can use the government's IHT calculator to determine whether your estate is eligible for the reduced rate.

Make a contribution to your pension.

You can designate who you want to inherit your retirement fund when you pass away, and it is typically free from IHT. Nevertheless, keep in mind that, as previously stated, this will change in April 2027, so you will need to reconsider this now or very soon.

Throughout your life, give gifts.

Giving assets to your loved ones while you are still alive will help you avoid inheritance tax. If your gifts are given less than seven years before your death and fall outside of the inheritance tax gift allowances, you might be required to pay inheritance tax.

Up to £3,000 can be given annually without incurring IHT. This allowance can be increased to 6,000 by carrying over unused allowances from the prior year. Additionally, you are free to give as many smaller gifts of £250 each as you like, as long as you haven't used another IHT exemption on the same individual. Children's wedding presents up to £5,000 and grandchildren's wedding presents up to £2,500 are also exempt. Generally, gifts known as potentially exempt transfers (PETs) made more than seven years prior to death are exempt from IHT. IHT is due on a sliding scale if you pass away within seven years of giving the gift. If you pass away within three years, the full forty percent rate is applicable; if you pass away six or seven years after the gift, the rate drops to eight percent.

Purchase life insurance.

To provide your family with a lump sum payment upon your death, you could purchase a whole life insurance policy if you know that your estate will exceed the IHT threshold. Any owed IHT could be paid with this money.

However, be sure to have a life insurance policy written in trust. In this manner, it will not be regarded as part of your estate and can be paid out without a probate being granted.

"This is generally a much more efficient way of funding the liability and it solves a cashflow issue many executors face," stated Ian Dyall, head of estate planning at wealth manager Evelyn Partners.

Before probate can be granted, inheritance tax must be paid, but probate must be granted before the estate's assets are released.

Purchase AIM stock.

You can invest in smaller businesses with AIM shares, which might have IHT advantages. Some of these shares are exempt from IHT because they are eligible for business property relief.

Note that this will alter starting in April 2026 due to an IHT crackdown. The rate of business property relief for shares that are "not listed" on the markets of a recognized stock exchange, like AIM, is being lowered by the government to 50%. This implies that a 20% IHT rate will be used.