The idea of passing your wealth to loved ones after you’ve gone seems a relatively simple wish, but it is one that can also come with complications.

In cases where legacy plans are not thought through in detail, or where they are not kept up to date, unprepared family members can find themselves having to deal with a potentially difficult financial situation after the death of a family member.

One of the major factors at play here is inheritance tax. Formalised with its current name in the Finance Act of 1986, inheritance tax has been a fixture of the UK taxation system for more than a century, although the concept of a duty payable on personal estates after death stretches back as far as the probate duty on wills in 1694.

Today, inheritance tax is paid to HM Revenue and Customs (HMRC) when the value of the estate (the property, money and possessions) of the deceased individual exceeds the threshold of £325,000, known as the nil-rate band. Tax is typically charged at the rate of 40% in relation to the part of your estate above this threshold.

This threshold can increase to £500,000 if you are giving away your main residence to children, including adopted, foster or stepchildren, or grandchildren. This is known as the residence nil-rate band.

Increasing numbers impacted

Over the past decade, increasing numbers of families have been impacted by inheritance tax, with the duty netting the Exchequer increasing sums of income largely as a result of sustained buoyancy in the property market.

In the 2020/21 tax year, data from HMRC shows that 27,000 estates attracted inheritance tax, representing a year-on-year increase of 17%. With an average bill of £214,000, these estates generated a record high of £5.76 billion in liabilities for the government – up 16%, or £0.8 billion – on the previous year.

These increases are even more significant when compared with figures from a decade earlier. Back at this time, the number of taxpaying estates was only around 15,000 and the total liabilities generated was less than half of the level reported in 2020/21.

Forecasts suggest that inheritance tax receipts will continue on their upward trajectory, with the Office for Budget Responsibility suggesting they could be as high as £8.4 billion by 2027/28. Gains in the value of assets such as property continue to drive this trend, but it can also be attributed to the fact that there has been no corresponding increase in the nil-rate band.

While this threshold increased from £231,000 to its current level of £325,000 in the ten years between April 1999 and April 2009, it has remained at this level ever since. Furthermore, the government has stated that it will be locked in place until at least April 2028.

Penalties and planning

This combination of factors makes it increasingly likely that families will be facing the prospect of paying inheritance tax and, in turn, it also increases the likelihood that they could risk penalties if they fall foul of the payment rules.

Data from HMRC reveals that fines levied against families for late filings or payments, or where assets have been undervalued or not disclosed, reached a total of £2.28 million in 2022. This is up from £1.70 million the previous year, representing a rise of 34%.

The level of the fine depends on whether the errors are the result of not taking ‘reasonable care’ or whether they are deemed to be ‘deliberate’ or ‘deliberate and concealed’. In the case of the latter, the penalty can be as much as 100% of the extra tax due.

Arguably the most straightforward way to manage the problem is to leave everything above the £325,000 threshold to a spouse or civil partner, which results in no inheritance tax being due. The same applies if everything is left to a charity or community amateur sports club, and it is also worth noting that you may still need to report the estate’s value even if it is below the threshold.

Further reliefs and exemptions are also available. Taper relief, for example, can mean inheritance tax is charged at a lower rate for gifts given within seven years of your death, and Business Relief can allow some assets to be passed on free of inheritance tax or with a reduced bill. Trusts can also be used as a means of managing assets so that they fall outside of your estate for inheritance tax purposes.

Exploring opportunities such as this can be helpful in light of the growing potential for more estates to attract higher levels of inheritance tax. By putting wealth strategies in place to limit your liabilities you can protect more of your legacy for your loved ones while also protecting them from the complications that can arise at an already difficult time.

The information contained within this communication does not constitute financial advice and is provided for general information purposes only. No warranty, whether express or implied is given in relation to such information. Vintage Wealth Management or any of its associated representatives shall not be liable for any technical, editorial, typographical or other errors or omissions within the content of this communication.