Why should we care about inheritance tax?

It has always felt like a problem only the rich have to worry about.

But as rumours circulate over an inheritance tax raid and warnings grow over the impact of house prices on the value of our personal estates, more of us need to start taking this eye-watering 40 per cent tax seriously.

Or do we?

The first thing to look at is the numbers, which unhelpfully, are always a little out of date.

The last recorded figures are from 2017 to 2018 when just 3.9 per cent of deaths reported the charge. This was a fall from 4.6 per cent the year before, because of the introduction of the residence nil rate band in 2017, which increased the limit at which the tax is due for some estates.

That’s around 25,000 estates, which is a relatively small number. However, the figures are expected to be much higher for the past year, because of the surge in deaths from the coronavirus pandemic.

So why is there such an outburst each time there’s talk of inheritance tax being changed or increased? It’s to do with how much is charged.

In the past 10 years the amount paid in IHT has roughly doubled, mainly because of the colossal increases in house prices and investments, and the average sum paid from 2017 to 2018 was £197,000.

The annual cap we are all allowed to bequeath without inheritance tax being due is currently £325,000. There’s also the residence nil rate band of £175,000, but only if you pass a main residence onto a child or grandchild.

There are strong arguments for and against the tax.

If you’ve spent your life building up your wealth to hand down to your family, and you’ve already paid tax on it once, you’re not going to be happy if another 40 per cent of it goes to the Treasury.

Similarly, if you want to give younger relatives any chance of buying their own home, rising rents and property prices mean this might be the only way to do it.

At the same time, the entire point of IHT is to rebalance wealth and to prevent inheritance from making the rich even richer.

Plus, if you’re wealthy enough to have an estate big enough to be taxed, you could argue that the money may be better served elsewhere, such as on the health, social care or education sectors.

Sarah Coles, spokesperson for Hargreaves Lansdown, says: “There are a few reasons why people resent paying inheritance tax. It can feel that these are things you have paid tax on when you earned the money, and again when it grew, so this is yet another level of taxation on the same money. Plus, although only a few people pay it, if you face it, it’s a punitive level of taxation – at 40 per cent.”

Sarah adds: “Some people try to find a way around paying it, but there are rules in place which put a stop to many of the most common wheezes.

“For example, if you sign over ownership of the family home to the children to prevent it falling into your estate, if you’re still living in it and not paying market rent to your children, it’s still included in your estate for inheritance tax purposes.”

One of the most common ways to reduce an IHT bill is by writing a will, which ensures your wishes are carried out, allows you choose where you estate goes, and if you are married couple or part of a civil partnership, you are able to pass your inheritance tax allowance to your partner on the first death.

Leaving the money to a charity or a community sports club also means there is no tax due.

You are also able to legally give away £3,000 in gifts each year, plus £1,000 per person for wedding gifts – or £5,000 for a child and £2,500 for a grandchild – as well as small gifts of up to £250 per person.

Regular gifts can be made from your income, if they don’t impact your standard of living, while larger sums of money can also be given as gifts, as long as you live for at least seven years after making them.

It’s also important not to forget pensions, as pension balances are free from the tax.

Steve Webb, partner at consultants LCP, said: “Although fewer than one in 25 estates face an IHT bill, the tax still generates valuable revenue for the Treasury.

“It is a complex tax which means that some people choose to organise their affairs to avoid leaving their heirs with an IHT bill when they die.

“One popular route is to give money away and, provided the donor survives more than seven years after the gift is made, the money will not normally count as part of their estate for IHT purposes.”