Inheritance tax is a complex and multi-faceted area of taxation law, and it’s set to change in January 2022.
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Part of the intention is to simplify the process, with returns not required from 90 per cent of estates where there isn’t any inheritance tax liability to pay.
However, when balanced against freezes in allowances, inflation and rising house prices, it’s not all necessarily good news.
This guide explains everything you need to know about how UK inheritance tax is changing from the start of 2022.
Inheritance Tax Bands
Two different thresholds relate to inheritance tax (IHT), which is charged at 40 per cent on a standard basis:
- The residence nil-rate band, or RNRB, is the maximum a property price becomes liable for IHT.
- The general nil-rate band (or NRB) applies to all other assets.
We need to clarify that the RNRB can apply on top of the general NRB, but only if specific conditions are met.
You don’t need to submit an IHT claim for exemption for properties worth under the cap, and you can pass on unused RNRB to a surviving spouse or civil partner.
The nil-rate band has been set at £325,000 since April 2009. As confirmed in the autumn budget, it is sticking at £325,000 until at least the start of the 2026 tax year.
For homes, the RNRB has increased by £25,000 every year since it was first introduced in 2017. This allowance is also paused at the current £175,000 until 2026.
This threshold was intended to increase annually according to inflation from 2021/22 onwards, but this system has been scrapped.
A further change is that the tapered tax relief, which reduces your tax bill on gifted wealth over the IHT allowance, has been frozen at £2 million.
The Impact Of IHT Threshold Freezes
These changes mean that as homes appreciate and salaries rise, more and more families will be exposed to IHT when a loved one passes away.
If we consider that the average property has grown up to 13 per cent per year in the intervening period, per Statista, it’s clear that millions of UK homes will now hit the threshold and be subject to IHT.
From 2009/10 to 2017/18, the average gross estate value across the UK grew from £35 billion to £100 billion, with 58 per cent of the growth linked to residential properties, and prices continue to rise.
For example, in London, the average home is worth £496,000, and so unless there are transferable allowances at play, a higher proportion of estates in the capital will have to pay IHT.
The government has introduced these changes to recoup economic losses suffered due to the pandemic – and the scheme is expected to generate a £985 million government payday from now until the 2025/26 tax year.
However, the effect on families will be significant, and any stealth tax can be viewed as a covert way to increase the tax burden on individuals rather than targeting big business.
There is also an imbalance whereby higher value estates tend to attract tax reliefs that provide a lower effective tax rate than those less wealthy.
Estates including securities or other assets may be eligible for agricultural property relief (APR) or business property relief (BPR). These allowances mean that an estate worth over £10 million will attract tax relief of an average of 70 per cent of the total estate value.
Quantifying The Number Of Estates Subject To IHT
The majority of estates are not liable for IHT, and in the most recently available 2017/18 figures, only 3.9 per cent of UK deaths generated an IHT bill for the estate beneficiaries.
This figure has fallen from 4.6 per cent in the previous tax year, owing to the new RNRB threshold, protecting 0.7 per cent of residential homes from the tax.
Government projections indicate that 94 per cent of estates will not have any liability in the next five years.
Still, the frozen thresholds will impact 161,900 families, 12,700 of whom would not have been liable if the allowances had increased as initially announced.
A new Pay Your Inheritance Tax Bill, published by the government, is intended to support heirs falling into this new bracket.
How IHT Disclosures Are Changing
The positive news is that currently if the legal assets require probate, every estate needs to submit extensive documentation.
The short-form is eight pages long, and the full version considerably longer, and one of the new rules relaxes the requirement to complete this paperwork if there isn’t any tax charge arising.
Probate isn’t required, if:
- All assets within the estate were jointly owned and passed to the surviving owner.
- The estate doesn’t include any land or property.
- Shares or bank accounts are valued at under £5,000 each.
Estates without an IHT charge will likely avoid the substantial tax forms from January 2022, including estates where the total net value of assets is below the £325,000 cap.
Some estates will avoid IHT if the net value is £1 million or less and is passed to direct descendants such as children or grandchildren.
In this scenario, if there are two NRB thresholds of £325,000 applied, plus two RNRB allowances of £175,000, an estate valued at £1 million will not be taxable.
However, if the second spouse passes away, beneficiaries must claim the transferable allowances, and so the estate will need to complete the inheritance tax forms at that stage.
IHT Changes From January 2022 FAQ
How can I check if my estate is liable for IHT?
The best way to verify whether you are exposed to IHT is to consult a finance professional who will carry out a valuation assessment for you.
Otherwise, you can calculate the estate value yourself by:
- Adding up all assets and debts, including balances in accounts and debts owing.
- Estimate the value of properties through an independent valuation or by looking at comparable property sales for a rough indication.
- Deduct all debts from the assets to arrive at an estimated net worth.
Valuing an estate through probate can take up to nine months and potentially longer if there are complications, so it’s wise to check if probate is required as a first step.
When is IHT payable?
If the estate isn’t liable to IHT, you don’t need to value it straight away.
However, if you need to pay an IHT bill, you have one year to submit your documentation.
Taxes payable must start being paid by the end of six months after the estate owner passes away, and you can start making payments before the valuation process is finished.
Can I Reduce My IHT?
There are multiple allowances and tax reliefs available. One route is to gift assets to family members or intended beneficiaries – if you live seven years after making the gift, it is not subject to IHT.
However, gifted assets or wealth are taxable if you pass away within seven years, although the tax rate is applied on a sliding scale.
UK taxpayers can also give up to £3,000 a year tax-free or £5,000 when a child gets married.
Other possible ways to reduce your tax bill include putting assets into a trust for the benefit of your children, taking out life insurance to the value of your anticipated IHT charge, or gifting some of your estate to a charity in your will.
If at least ten per cent of your will is left to charity, then the IHT rate on remaining assets drops from 40 per cent to 36 per cent.
A financial adviser can provide advice about available allowances and which apply best to your circumstances.
Can I pay IHT in instalments?
Yes, you can opt for the Instalment Option, which means you pay IHT on some assets over ten years in equal payments.
Qualifying assets include:
- Houses or land.
- Shares and securities where the estate includes over 50 per cent of controlling shares.
- Businesses run for profit.
- Unlisted shares and securities in some scenarios.
What tax reliefs can I claim against IHT?
Some estate assets qualify for business relief, applied to shares or business ownership of up to 50 per cent, provided the deceased owned the business or shares for at least two years.
Agricultural relief applies where assets are used in farming and are exempt from IHT whether they are gifted or left in a will.
Assets falling under this relief need to have been owned for two years if the deceased lived in the property or their spouse, civil partner, or company occupied it.
If anybody else owned and occupied the agricultural property, it must have been held for seven years by the deceased to be eligible.
This IHT relief applies to most land, agricultural shares and securities, farm buildings (including cottages and farmhouses) and tree planting systems.
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