The Treasury is looking at ways to increase the money it collects through inheritance tax (IHT), sources have told the Guardian.
Ideas on the table include a review of the rules on giving away assets, with one possibility being the introduction of a lifetime cap on how much an individual can donate.
Any changes would come on top of other moves the government has already made to close IHT loopholes.
What is inheritance tax?
IHT is a tax paid on someone’s assets (property, possessions and money) after they die, but only if they leave enough to go above a certain threshold.
The standard IHT rate is 40%, and it is only charged on the part of the estate that is above the tax-free threshold – currently £325,000 for an individual.
However, the rules are complex and the threshold is different if a property is involved and can be higher if you are married or in a civil partnership and your partner did not use all of their allowance when they died.
What could be changed?
You can currently give away all of your money and assets to your spouse or civil partner, charities or political parties, or to anyone else as long as you time it right. Otherwise, there could be an IHT bill for your estate when you die.
One idea reportedly being considered is a lifetime cap on how much individuals can give away – anything above that would attract tax. This is the case in lots of other countries, including the US.
What do you mean about timing it right?
There is a currently a seven-year rule on gifts. If you give something to someone other than the exempt group, IHT may be due if you die within seven years of doing so. These gifts are called “potentially exempt transfers” because if you live long enough they are IHT-free.
The rule is designed to stop you giving away lots of assets at the last minute.
Anyone dealing with an estate – the executors or a solicitor employed by them – will be expected to declare anything the deceased has given away in the seven years before he or she died. The gifts are added up – starting with the earliest in the seven years – plus the rest of the estate. If the total comes to more than £325,000, it passes the IHT threshold.
For the first three years after you have made the gift, if you die it could attract a tax bill of 40%. After that the potential tax bill goes down incrementally each year, so in the last of the seven years it is 8%.
An alternative to a lifetime cap could be a change to the seven-year rule – the period in which you can make potentially exempt transfers could be reduced, and the taper made less generous.
Currently not everything you give away will be included in the tax department’s calculations: there are allowances you can use to make gifts.
What allowances are available?
Every tax year you can give away up to £3,000 without there being a potential for IHT. The money can go to one person or many.
You can also make “small gifts” of up to £250 a year to as many people as you want, as long as you have not used any of the £3,000 allowance on them.
Birthday and Christmas presents do not count towards these allowances.
There are also allowances for wedding and civil partnership gifts, of up to £5,000 if it is your child who is tying the knot.
Regular payments – for someone’s rent or into a savings account for instance – could also be tax free. For these to qualify as non-taxable they need to be paid out of your monthly income and leave you with enough money to live on. These are called “normal expenditure out of income”.
I’ve received a gift from someone who died, will I have to give part back?
Gifts are counted first before the rest of the estate, so most IHT will be paid for via other assets. However, in those cases where the total value of qualifying gifts is over the IHT threshold, the recipient may have some tax to pay.
It’s a wise idea for the donor and the receiver to keep records of large gifts, particularly if they are purposefully part of IHT planning. This will make it easier for the executors to work out what, if anything, must be paid.
What changes has the government already made?
In last year’s budget it made changes to the allowances around businesses and agricultural land. Since April a 20% tax rate has been applied to the value of farms and businesses worth more than £1m when they are passed on. Previously it was possible to pass these things on with no IHT tax bill.
Another change announced then will bring unused pensions into IHT. From April 2027 any unused fund that is being passed on will be included in the estate for IHT calculations. Currently pension money can be passed on without a bill.
The government this week confirmed that the pension rule will apply even if the person saving into the fund was too young to access it at the time of their death.
How much does IHT raise?
Only 4.6% of deaths resulted in IHT being paid in the tax year 2022-23, according to the latest figures from HMRC. The average effective tax rate for estates was 13%, after accounting for all the different reliefs and exemptions that might apply depending on the individual circumstances. That compares with the headline rate of 40%.
It is impossible to predict how much closing loopholes will bring in as changing the rules tends to lead to a change in behaviour. Not long after the pension change was announced there were signs that wealthy investors were starting to withdraw money from their funds.
A lifetime limit might change people’s behaviour as it could encourage people not to give away money early in their life. What difference it makes to the ultimate tax take will depend on the level it is set at and how it is applied to people who have already given away large sums under the current system.
