Key Takeaways
- Treasury looking at changes to lifetime gifting and the “seven-year rule”.
- UK government is under pressure ahead of the Autumn Budget to fill the estimated £20 billion gap in the public finances.
- Under changes announced in 2024, UK pensions will face inheritance tax exposure from 2027.
Speculation is mounting that the UK chancellor, Rachel Reeves, is looking to make changes to the inheritance tax regime in the Autumn Budget. These would follow previously announced changes to how pensions and family businesses are taxed after death.
The wider context is a need for the government to plug a hole in the public finances and avoid raising direct taxation, a manifesto promise it made before it was elected.
What Is Being Planned for Inheritance Tax Now?
The government is looking at restricting rules around gifting, which is a way of mitigating or avoiding inheritance tax by giving sums of money to children and grandchildren in an individual’s lifetime. The “seven-year rule” means that this person has to survive for seven years from the date the gift was made to face no inheritance tax. The scope of the gift can be wide and include cash, jewellery, property, stocks and even antiques, but there is an annual gifting limit of £3,000.
Hudda Morgan, a partner at law firm Spencer West, noting that this tax break only exists in the UK, suggests that the government could go down the route of capping gifts.
And if gifting is abolished altogether, then the inheritance tax limits could be increased to compensate, she says. Then “only substantial gifting from the very wealthy” would be caught in the tax net.
What Changes Have Already Been Made to UK Inheritance Tax?
In the 2024 Autumn Budget, the government sent shockwaves through the financial advisor community and among pension savers, by changing the rules over pension pot taxation from 2027. Previously, equity-based pension savings accumulated over a lifetime would be free of inheritance tax in most circumstances. From 2027, the deceased’s relatives may face paying a 40% tax bill on this pot. This aligns pension savings with tax rules on Individual Savings Accounts, or ISAs, which are already subject to inheritance tax.
At the time the government said that “pensions should not be a vehicle for the accumulation of capital sums for the purposes of inheritance“.
Advisors at the time stressed that this change would shift the emphasis on lifetime giving, effectively running down liquid assets as much as possible to keep below the inheritance tax thresholds, which are explained below.
There were also substantial changes to how family businesses, such as farms, will be taxed, triggering street protests in London.
What Are the Current Inheritance Tax Rules?
- Effective tax rate of 40% starts at £1 million for a married couple.
- More estates are being dragged into the inheritance tax band as asset prices rise.
- But more than 95% of estates don’t pay this tax, although this is expected to rise.
- Tax is paid on total estate value, rather than on individual assets like property or share portfolios.
The current rules over UK inheritance are complicated and families, especially those most likely to pay inheritance tax, often use financial planners and accountants to navigate through the tax maze.
The tax is paid on the estate of a deceased person rather than by the individual during their lifetime.
The “nil-rate band” gives an individual a £325,000 tax-free allowance before paying inheritance tax at 40%; there are other allowances and a couple can combine their bands. Effectively, the maximum “allowance” is around £1 million for a married couple, including the residence nil rate band, a way of accounting for increasing house prices.
Who Pays Inheritance Tax and How Much?
As with income tax allowances, inheritance tax is also subject to “fiscal drag” because the allowance is being frozen at £325,000 until 2030, extending the freeze announced by the previous government.
Twenty years ago, inheritance tax brought in just over £3 billion in the 2005-2006 financial year; the latest HMRC data for the last financial year shows a rise to above £8 billion. This has coincided with a period of rising asset prices, including property and shares.
“The government is collecting more in death taxes than ever before,” says Charlene Young, senior pensions and savings expert at AJ Bell.
Still, less than 5% of estates actually pay inheritance tax.
