7 common but potentially harmful Inheritance Tax myths debunked

Inheritance Tax (IHT) is often controversial – you may have heard of it referred to as “the most hated tax in Britain”. Yet, despite the coverage it receives, it’s often misunderstood. Common myths about IHT could mean you’re needlessly worrying about a potential bill or failing to take steps that could allow you to pass on more wealth to your family.

Read on to discover seven common myths about IHT and better understand if it’s something you need to consider as part of your estate plan.

1. “Inheritance Tax makes up a large portion of HMRC receipts”

It’s not surprising that people often believe IHT makes up a large portion of the money the government raises through taxes. After all, it’s a tax you may hear more about than Capital Gains Tax or Corporation Tax.

Yet, a relatively small part of the government’s income comes from IHT.

In fact, government statistics show that in April 2023, it collected £0.6 billion through IHT. That may sound significant but it compares to:

  • £40.4 billion through Income Tax and National Insurance contributions
  • £17.9 billion from VAT
  • £1.2 billion from Stamp Duty Land Tax and Annual Tax Enveloped Dwellings.

So, while a standard 40% IHT rate can lead to hefty bills for individuals, it may not be boosting the government coffers by as much as you think.

2. “Only the super-rich will need to pay Inheritance Tax”

While it’s true that the majority of estates won’t be liable for IHT, it doesn’t just affect the very wealthy. Once you add up the value of all your assets, you may be closer to the IHT threshold than you believe.

For 2023/24, the nil-rate band is £325,000. If the value of your estate is below this, it won’t be liable for IHT. Many individuals leaving their main home to direct descendants can also make use of the residence nil-rate band, which is up to £175,000 in the 2023/24 tax year.

So, many people can pass on up to £500,000 before they need to consider IHT. According to a report in the FTAdviser, around 1 in 25 estates result in an IHT charge.

The £500,000 threshold may seem like a lot, but once you consider assets like your home, it can be easier than you expect to exceed it.

In addition, both the nil-rate band and residence nil-rate band are frozen until 2028.

So, over the next five years, a greater proportion of estates are likely to pay an IHT bill – the Office for Budget Responsibility estimates the freeze will increase IHT receipts by £35 million by the end of 2027/28.

3. “You can pass on £1 million before Inheritance Tax is due”

It’s easy to see where this myth comes from – it is possible to pass on up to £1 million without being liable for IHT. However, this doesn’t apply to all estates.

As explained above, the nil-rate band and residence nil-rate band add up to £500,000. If you’re married or in a civil partnership, it is possible to pass on unused allowances to your partner when you pass away.

As a result, when planning as a couple, you may be able to leave up to £1 million before IHT is due. However, it’s dependent on your and your partner’s circumstances and who you want to leave assets to.

4. “You don’t need to consider Inheritance Tax if you leave everything to your partner”

While you can leave assets to a spouse or civil partner without being liable for IHT, this isn’t a reason to skip estate planning.

Don’t assume your partner will automatically inherit all your assets unless it’s stated in your will.

If you pass away without a will, your assets will be distributed under intestacy rules. Under these rules, a spouse or civil partner will inherit everything if the value of your estate is less than £270,000. If it exceeds this amount, some of your assets could go to your children or other direct descendants.

While your plan may be to leave all your assets to your partner, what would happen if they passed away first? Or could their estate be liable for IHT after they’ve received your assets? Having an estate plan that covers different scenarios is valuable.

5. “Gifted assets aren’t liable for Inheritance Tax”

Giving away assets to bring the value of your estate under the IHT threshold may seem like a simple solution, but it isn’t as straightforward as that.

Some gifts are considered immediately outside of your estate for IHT purposes. This includes up to £3,000 (in the 2023/24 tax year) known as your “annual exemption”, up to £250 to individuals that have not received your annual exemption, and regular gifts made from your income.

However, many other gifts are “potentially exempt transfers”. This means they could be considered part of your estate when calculating IHT for up to seven years.

The rules around gifting and IHT can be complex. If it’s something you’re thinking about, we can explain your options.

6. “You can leave your home to children without paying Inheritance Tax”

This misunderstanding comes from the residence nil-rate band. While this allowance could increase how much you can leave behind before IHT is due, it may not be enough to cover the value of your entire property.

It’s also important to note that the residence nil-rate band does taper for larger estates.

In 2023/24, for every £2 your estate exceeds the £2 million Taper Threshold, your residence nil-rate band is reduced by £1. So, estates that are worth £2.35 million or more may not benefit from the residence nil-rate band at all.

7. “Assets held abroad will not be liable for UK Inheritance Tax”

If you’re a UK-domiciled individual, your worldwide assets are usually included when calculating the value of your estate and potential IHT bill. However, where assets could be liable for tax in other countries, you may receive credit so your estate isn’t charged twice.

IHT on assets abroad is complex. Seeking tailored advice can help you understand the potential bill your loved ones may face.

Contact us to discuss how you could reduce an Inheritance Tax bill

If your estate may be liable for IHT, there are often steps you could take to reduce the bill or provide loved ones with a way to pay it. You can contact us with questions you may have about IHT and to discuss your options.

Please note:

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The Financial Conduct Authority does not regulate estate or tax planning.