Inheritance tax receipts rise

18 March 2022

HMRC has announced that it collected inheritance tax (IHT) of £4.6bn between April and December 2021, an impressive increase of £600m, or 16 per cent, compared to the same period in 2020.

Why the increase?

£600m is a lot of money, but it represents around just 0.1 per cent of total annual UK tax receipts. The increase in IHT receipts may therefore not be a game-changer for the Government, but it can make life-changing differences to families who have to pay it.

The increase in IHT receipts in 2021 has many causes. These range from the practical (in 2020 HMRC’s ability to process payments was seriously disrupted and some tax was paid late), to the economic (rising asset prices and economic recovery means that the value of the estates of wealthy individuals is rising). And of course, Covid 19 will no doubt also have played a part by increasing the number of people who have sadly died in the last two years.

The increase also shows the effects of ‘fiscal drag’, where allowances and reliefs have not increased in line with rising prices. With inflation continuing to rise, this factor will play a big role in future tax revenues.

For example, the first £325,000 of a person’s taxable estate on death (the ‘nil rate band’) is taxable at zero per cent. This band has not increased since 2009 and has been frozen until at least 2026. This means that the tax-free band is not keeping pace with inflation. The effect is that, in real terms, the proportion of a person’s estate being taxed is going up. If inflation is 5 per cent, the value of an asset would need growth of an inflation-busting 8.33 per cent in order for its post-tax buying power to remain the same because IHT is payable on the growth inflation causes as well as growth caused by the success of the investment itself.

By freezing tax bands and allowances the Chancellor is increasing tax receipts without changing tax rates. In periods of high inflation, the effect is magnified, and the buying power of a family can be severely reduced over time.

What can be done?

The UK IHT system offers a few ways that may prevent individuals from suffering large IHT liabilities on death. Very importantly, amounts inherited by spouses or civil partners are not subject to IHT at all, but bequests to other family members or co-habitees are taxed, including gifts to ‘common-law’ (ie unmarried) partners.

One solution is to make lifetime gifts. In most cases, no IHT is payable on gifts made more than seven years before a person’s death. Gifts made between three and seven years before death are taxed at lower effective IHT rates, but those within three years of death get no reduction.

Giving assets away while you are still healthy is therefore good IHT planning – but only if you can afford it. If you make a gift but later benefit from the asset you gave away, the gift will be ignored and its whole value will be taxable on your death.

Certain types of asset qualify for an exemption from IHT once they are held for at least two years. These include interests in qualifying businesses and shares in unquoted trading companies. This can be a very valuable exemption, but the rules governing which investments qualify need to be considered and applied carefully to benefit.

The value of pension funds may also be exempt from IHT on an individual’s death, but this can be challenged if a person deliberately chooses not to take benefits in order to preserve value for their heirs. This is a particularly complex area of the IHT rules and if you have substantial pension funds you should take advice on how they may apply to you.

Finally, do not underestimate the value of life insurance. Insurance can be useful for a fixed period – for example, while you have young children or for the seven years after making a gift. It can also be a good way to make sure that your family will have enough cash after your death to pay any IHT that is due.

Up-front planning

We all know the saying that nothing in life is certain but death and taxes. IHT combines these two certainties and thinking about how to deal with them early can save your family a lot of difficulty in the future at a very emotional time whilst preserving value for the next generation.

For more information, please get in touch with Andrew Robins, or your usual RSM contact.