Is UK Inheritance Tax as bad as it seems?

Inheritance Tax (IHT) is often regarded as the most unpopular tax in the UK. Not only is it punitive (charged at a rate of 40% after reliefs and exemptions), but many taxpayers question the fairness of a tax on assets at death when those assets have already been subject to taxation during their lifetime.

The reach of IHT also continues to expand. The number of estates falling within the scope of this tax surged from 23,000 in the 2019-20 tax year to 27,000 in the 2020-21 tax year, an increase of 17%. The appreciating values of real estate, investments and savings means even relatively modest estates are now exceeding the IHT threshold. The proportion of deaths resulting in IHT is set to grow from 4% in 2020-21 to over 7% by 2032–33.

Regarding IHT in the UK, there is an allowance called the ‘nil-rate band’, which allows you to leave £325,000 worth of assets tax-free, or £500,000 if you leave your primary residence to a direct descendant like a child or grandchild. Assets left to a spouse or civil partner are also exempt from IHT.

Furthermore, if your allowance remains unused when you pass away, it can be inherited by your partner, potentially allowing them to leave up to £1 million worth of assets tax-free upon their death. Anything above this allowance is subject to the 40% tax rate.

According to YouGov polls conducted in 2021 and 2022, only one in five people regarded IHT as equitable. Many believe that people should not be penalised for wanting to pass on their wealth to their children, while others, including the influential Institute for Fiscal Studies (IFS), are calling for an urgent reform.

The IFS argues that that, as currently designed, IHT has only a small impact on the distribution of inheritances received and therefore on intergenerational wealth mobility. It also argues that various reliefs and exemptions are inequitable and distort economic decisions, while the residence nil-rate band is of greater benefit to those in London and the South.

With more than 95% of estates currently excluded, IHT revenues are small, at £7 billion (or 0.3% of GDP) a year. But this means that the whole burden is being shouldered by a relatively small number of taxpayers. So how severe is the situation in the UK when compared to other countries? Let’s delve into the details.

The UK stands out as one of the few nations that imposes IHT on the estate of the deceased, most countries tax the recipients of an inheritance instead. Notably, Australia abolished IHT in 1979 and even Sweden, known for its high taxes, followed suit in 2004. In the US, the top rate of federal estate tax matches the UK at 40%, but the threshold is USD12.92 million for individuals and USD25.84 million for married couples.

According to the OECD, only 4% of estates incur the tax in the UK, compared to 10% in Germany and a whopping 48% in Belgium. In the US, so few people pay estate tax that it barely registers in the statistics.

There are strategies to mitigate the impact of IHT in the UK that require careful planning and will depend on your circumstances. Sovereign has many years of experience in IHT planning for its global client base. Given the implications of not planning correctly for IHT – potentially handing 40% of your estate over to the government rather than to those you love – we urge you to contact us. Sovereign Corporate & Trustee Services (SCATS) can help navigate you through the process. Please contact us for more information.