The ‘most hated’ tax: inheritance. Is that fair?

We talk about the rules around gifting while you’re still alive, life insurance, the importance of wills, and how inheritance will be divided in the absence of one.

Use the player icons above to listen on your favourite podcast app, or read the full transcript below.

This podcast isn’t personal advice. If you’re unsure what’s right for you, seek financial advice. Pension and tax rules can change, and benefits depend on personal circumstances. Investments can fall as well as rise in value, so you could get back less than you invest.

Full podcast episode transcript

[0:05] Helen Morrissey: Hello and welcome to the Switch Your Money On podcast from Hargreaves Lansdown. I’m Helen Morrissey – Head of Retirement Analysis.

[0:12] Clare Stinton: And I’m Clare Stinton – Senior Personal Finance Analyst.

This week, we’re talking all about Inheritance Tax – probably the least-liked tax of all, often described as the most hated tax because there is a belief or a feeling that, actually, you end up paying tax on money that you’ve already paid tax on.

Inheritance tax receipts have been rising, up to £7.1bn in the first 10 months of this year – and that’s up £130m on the same time last year – and it looks set to deliver another record-breaking payday for the Treasury this tax year. But how many of us will actually pay it?

[Pause]

[0:50] Clare Stinton: It’s an area of Personal Finance that has a lot of emotions tied to it – it’s hard to think about our own mortality, and often even harder to think about a loved one’s mortality. So, conversations around planning can be uncomfortable and they’re often avoided.

It’s also a complex area of financial planning – there are quite a few rules, which can make it difficult for people to understand their position. So, it’s probably also fair to say that it’s one of the most misunderstood taxes here in the UK.

So, in today’s episode, we’re going to be doing a bit of myth-busting.

[1:28] Helen Morrissey: Yeah, absolutely right, Clare. So, alongside that myth-busting, we’re gonna be covering a whole array of different issues – such as, ‘Who will pay Inheritance Tax?’ – and we’re also gonna explain how the gifting rules work.

Now, some of the allowances are ‘Use it or lost it’ each tax year – so, with tax-year end coming up very soon, we are gonna be flagging those. We’re also gonna discuss the ways that estates that are likely to pay Inheritance Tax can mitigate it, as well as some of the changes to IHT and pensions that are coming up in April 2027.

[2:00] Clare Stinton: Lots to cover – so let’s jump into busting our first myth of the episode. It’s also going to double as our stat of the week – and, Helen, I’m turning the tables... after my hat-trick, I thought I’d test you!

So, as many as 40% of people worry about Inheritance Tax, but what percentage of estates actually pay Inheritance Tax?

[2:20] Helen Morrissey: Okay – the pressure is on – I need to get this right, and I’m actually quite relieved because I write about this quite a lot, so I do think I know the answer. I would say it’s between 4% and 5% of estates – am I right?

[2:31] Clare Stinton: That’s right – yeah. So, in tax year ’22-’23, around 4.62% of estates paid Inheritance Tax, and that works out to be about one in 20 estates. So, far less people are paying it than the number of people that are concerned about it.

Now, we should say that the amount of Inheritance Tax going into the taxman’s pocket is rising – the number of estates paying it is also expected to double to around one in 10 estates by 2030/2031.

Now, that is due to a few factors. First, we’ve got rocketing house prices – which, of course, pushes up the value of your estate – but what else is driving the rise, Helen?

[3:07] Helen Morrissey: So, yeah, you’re right – there’s a few things that are driving the rise in receipts, and we will talk about them in a bit more detail later. So, first of all, it’s frozen tax thresholds – which are playing their part – and then also it’s the move to include pensions and people’s estates for inheritance tax purposes, which is coming in from April 2027... that’s also gonna have an impact.

However, before we go into that detail, I wanted to be clear that receipts are rising for Inheritance Tax, but I just wanna make sure that people aren’t worrying about nothing.

So, you mentioned there the 4%-5% of estates that currently pay Inheritance Tax. Now, that will go up, but there’s still gonna be about 90% of estates that won’t fall into the net, even with the changes that we’re about to go through. So, by making sure that you understand these rules, you can make sure that you’re making the right planning decisions for you.

So, first up – as I said – is frozen tax thresholds. So, Inheritance Tax kicks in when your estate is worth more than £325,000. Now, this is known as your nil rate band – so, if all your assets are worth less than this, then you don’t really have an IHT problem. This has been frozen since 2009 – so quite a long time – and, to be honest, there’s no change in sight for these tax thresholds to go up until at least 2031.

Added to this, if you’ve got a property that you want to pass down to a child or a grandchild, you will get a further nil rate band – it’s called the Residence Nil Rate Band – and that’s worth up to £175,000.

Added to this, if you’re married, it’s also worth saying that you can pass any amount from your estate to your spouse or civil partner – and it’s free of Inheritance Tax, no matter what its value is. You can also inherit your partner’s nil rate bands. So, this means that you could potentially pass on up to £1m before your estate is subject to Inheritance Tax.

So, if you bear all of this in mind, there is gonna be a lot of estates that won’t have to pay Inheritance Tax – however, I do need to mention cohabiting couples here. You know, you could live together for 20 years – and bring up a family together – but, if you aren’t married, or in a civil partnership, then you won’t get the exemptions that married couples do, and you could be left with a hefty and unexpected bill.

[5:34] Clare Stinton: So, there was quite a few figures there, so let’s unpack that a little bit more.

So, for married couples with children... if your estate is under £1m, you often don’t need to worry about Inheritance Tax – but, for anyone unmarried, with an estate over £325,000, that could fall into scope. So, arguably, it does require more planning.

If someone in an unmarried couple leaves all of their assets to a partner, then their threshold is £325,000. But, if they leave part of their share of a property to a child, they could pass on up to £500,000 without paying Inheritance Tax – and that’s the combination of that nil rate band, Helen, that you mentioned, plus the Residence Nil Rate Band. Their partner could then do the same, which would get them to that same £1m total, albeit it’s a bit more complicated and it needs a bit more thought.

So, actually, that piece of paper – the marriage or civil partnership certificate – is really worth quite a lot of money when it comes to Inheritance Tax.

Helen, the 2024 Autumn Budget announced changes to pensions and Inheritance Tax, which you’ve already eluded to – what do we all need to know?

[6:40] Helen Morrissey: Yes – so, as well as the frozen thresholds that we spoke about earlier, it’s also coming up to the one-year countdown of most pensions becoming part of your estate for inheritance tax purposes.

The number of estates paying this tax has been increasing over the years – again, often due to increase in house prices – but this move is gonna bring far more people into the net, just because of the value of those pensions – so planning is starting.

[7:06] Clare Stinton: So, the time is now for people to review what they’ve got and whether they’ll fall into the inheritance tax net.

What should people be thinking about if they do have a looming inheritance tax liability?

[7:17] Helen Morrissey: Yes – so one option could be to gift money away while you’re alive, so you reduce the value of your estate. This can be beneficial, as you can help your loved ones meet their financial goals a bit sooner – and I think you also get to see how they will deal with a windfall – and I think that could well inform how you gift to them in the future.

[7:37] Clare Stinton: That’s really interesting.

We should stress that, before making any gift, make sure you can afford it, that it works with your long-term plan, and that giving it isn’t going to leave you financially short. You absolutely don’t want to end up in a position where you’ve given loved ones money, only for them to need to give some back – provided they haven’t spent it, of course.

Now, if you are in the fortunate position to be able to gift whilst alive, there are various rules and allowances that you need to be aware of first – what are those, Helen?

[8:04] Helen Morrissey: Yeah, so there’s a few.

So, first up, gifts of any value can be made to individuals, and they will pass out of your estate for inheritance tax purposes after seven years... these are known as Potentially Exempt Transfers.

Now, if you were to die within those seven years, Inheritance Tax may need to be paid – though, potentially, at a reduced rate. Added to this, there are various allowances that you can make use of. So, first up, you can make use of your £3,000 annual allowance to gift to loved ones. You can also carry forward any unused annual exemption into the next year, but you can’t go any further back than that.

You can also gift up to £250 to any number of recipients, but you can’t gift it to somebody who you’ve also made a gift to using another allowance – so it’s a bit complicated.

[8:58] Clare Stinton: Okay – and this is one that definitely causes confusion.

So, to be really clear – Helen, if you, very generously, decided to gift me £3,000 – using your annual allowance – you couldn’t then also give me an extra £250 in the same tax year without it potentially being subject to Inheritance Tax. elenHelen

[9:16] Helen Morrissey: Exactly. So, if I did give you £3,250, then anything over the available annual allowance would be classed as one of those potentially exempt transfers – meaning that I’d have to live for seven years after gifting it to you for it to become IHT-free.

As well as those gifting allowances... if a loved one is due to get married, then you’ve got some allowances there too. So, you can give up to £5,000 to a child, £2,500 to grandchildren and great-grandchildren, and £1,000 to anyone else – and it will come out of your estate for IHT purposes immediately.

These gifts need to be made on or before the wedding, and the wedding does need to go ahead – so that’s important. Gifts to charities and political parties can also be made inheritance-tax-free.

On death, if you gift at least 10% of your net estate to a UK registered charity, you will see the rate of Inheritance Tax that you pay on your remaining estate drop.

[10:21] Clare Stinton: Yes – if you leave more than 10% of the net value of your estate – so that is your estate’s total value, minus any debts, reliefs, exemptions, and nil rate band – then the inheritance tax rate drops from the standard 40% to 36%.

I actually bet that COVID and all of the impact on postponed, cancelled, and rearranged weddings must have caused some real admin headaches – especially with that condition that the gift only applied if the wedding went ahead.

So, we’ve covered gifting from savings and investments – what about gifting from surplus income?

[10:54] Helen Morrissey: Yeah – so this is what’s known as ‘Gifting out of excess income.’ This means that you can give away any amount, and it comes out of your estate for inheritance tax purposes immediately – however, there are caveats.

So, the gift needs to come from income, not capital – first of all. It needs to be made on a regular basis, and it must not affect your standard of living. So, an example of this could be paying school fees for a grandchild.

It’s a really handy rule, but you must make careful notes, so that your loved ones can demonstrate that the gifts have met all of this criteria if they are asked. It’s a good idea to get help from a financial advisor, to make sure that you stay on the right side of the rules – something worth considering.

Now, Clare, I know that you’ve already touched on this, but I would really like to say the importance of not gifting too much away too soon. You know, none of us know how long we’re gonna live – and we don’t wanna leave ourselves running short of money later on in life. You have to take account of things like potential care bills, for instance, before you decide to gift any money to anybody else. You also need to make sure that, when you gift something away, then that actually is what you’re doing.

So, for instance, if you were to gift your home away to a loved one – or continue to live in it rent-free – then that could be seen as what’s known as a ‘Gift with Reservation’ – it would be seen that you are still benefiting from it. If this is the case, then you would still likely have an inheritance tax bill, as it would still be seen as part of your estate.

[12:30] Clare Stinton: Okay – really important to point that out. And, going back to those gifts from surplus income, typical sources of income would be earnings, pension income, rental income, interest, or dividend income – and, Helen, as you say, the key is clear, regular record-keeping of what you’ve gifted, when, and to who.

Many of the gifting allowances provide a way to reduce the value of your estate gradually – so, as is always the way, planning and preparation are key here.

Another myth is that Inheritance Tax is always taken and paid from the estate, but what is the reality, Helen?

[13:04] Helen Morrissey: Okay – so Inheritance Tax is due six months from the end of the month that the person died. As an example, if someone died in early June, the bill needs to be settled by the end of December.

It’s not automatically deducted – it’s the executor’s responsibility, if there is a will, to ensure that it’s paid. In some circumstances, assets may need to be sold to pay that inheritance tax bill, and it’s worth saying that this can take time – particularly if it’s something like a house... then you may be able to pay in a series of instalments.

So, while Inheritance Tax can be paid from the person’s estate, there is also the option to pay directly from funds that you’ve got – or from the executor’s funds. Alternatively, the executor can borrow the money as a loan – they then have to reclaim the amount that they’ve paid from the estate.

[13:57] Clare Stinton: And, for those worried about leaving loved ones with an inheritance tax bill, taking out life insurance written in trust can help cover it.

By placing the money in trust, it doesn’t form part of your estate – and that can help to ensure the money is available quickly for your loved ones in order to pay the inheritance tax bill. You’ll pay a monthly premium – and the cost will depend on your age and health when you take out the policy – but it can be a small price to pay for peace of mind.

So, in the spirt of myth-busting, another myth is that life insurance is really expensive – and so I ran a quote for a 60-year-old looking to assure £150,000 – the term was for 20 years. So, non-smoker, no health issues – and the cost came out between £70-£80 a month. Of course, if you do have health concerns – or you do smoke, or you are heavy drinker – then that is likely to increase the price per month.

The reality is, the younger that you are when you take out life insurance, typically, the cheaper the cost. And related to this, is something that I think really flies under the radar – and that’s, ‘What happens to someone’s estate if they die without a will?’

[15:03] Helen Morrissey: Yeah – so, if someone dies without a will, then something called ‘The Laws of Intestacy’ will determine who inherits the estate.

So, typically, this means a spouse or civil partner inherits. If there are children involved, the spouse would inherit only the first £322,000, plus half of the remaining estate, with the other half divided among the children.

Be warned though that, for couples who’ve separated, but are still married, the spouse still inherits – and this may mean that somebody who the deceased didn’t want to receive the assets still gets them.

Unmarried partners would not inherit. It’s unlikely that grandchildren inherit because, if their parents are alive, it would go to them – and, if there are no living relatives, it will pass to the Crown – so it’s worth considering all these things.

[15:56] Clare Stinton: Really good to flag that point around couples who’ve separated but are still married – that the spouse would inherit – ‘cause I imagine there are couples who haven’t got divorced because of the cost – or they haven’t got divorced because of the children – so really important to flag that.

Those rules are really outdated for the kind of modern, blended families that we see today – which is why it’s so important to take the time to create a valid will. And, just because someone has written a will, at some point, doesn’t necessarily mean it will still be valid when they pass away.

Certain life events – like getting married – can actually override an existing will, so it’s a good idea to review it every so often. If a will does exist, but it is found to be invalid, the estate will be treated as intestate.

So, that’s it for this week – but, before we go, we should remind you this was recorded on March 17^th and all information was correct at the time of recording.

[16:49] Helen Morrissey: Nothing in this podcast is personal advice – if you’re unsure about what’s right for you and your circumstances, you should seek advice.

[16:57] Clare Stinton: Tax rules can change and benefits depend on circumstances. Pension money can’t normally be accessed until 55, though this is rising to 57 in 2028.

[17:07] Helen Morrissey: So, all that’s left now is for us to thank your Producer, Elizabeth Hotson.

[17:11] Clare Stinton: And to thank you all, very much, for tuning in – we’ll be back again soon. Bye!

[17:15] Helen Morrissey: Bye!