5 popular Inheritance Tax myths you should be aware of

As Benjamin Franklin once famously retorted: “nothing can be said to be certain, except death and taxes”.

In the UK, not even your death can escape the clutches of HMRC. In the 2022/23 tax year, HMRC reports that estates paid an eye-watering £7.1 billion in Inheritance Tax (IHT), up by £1 billion from the same period a year earlier.

With IHT charged at a rate of 40% on assets above your nil-rate bands, it can eat into your legacy and leave your loved ones with a sizeable bill when you pass away.

Understanding IHT is the first step to taking steps to mitigate its effect. So, here are five popular and common IHT myths – and why you shouldn’t believe them.

1. Only the very wealthy pay IHT

Every individual benefits from a “nil-rate band” of £325,000 meaning you can pass assets valued at up to this amount on your death before IHT is due. If you plan to leave your main residence to a direct lineal descendent then you may also be able to use the additional “residence nil-rate band” of £175,000.

As you can pass any unused IHT allowance to a spouse or civil partner on death, it is possible to pass up to £1 million without IHT being due.

So, one common myth is that only the very wealthy pay IHT. However, as property prices and assets rise while the nil-rate bands remain frozen, more and more estates are facing IHT issues.

HMRC say that, in 2019/20, 3.76% of estates faced an IHT bill, equivalent to around 23,000 deaths. And, as you’ve previously read, the number of families paying IHT is set to double by 2026.

You’ll likely have seen the value of your home rise sharply over recent years and this, coupled with your other wealth, could easily see you exceed the nil-rate bands when you die. So, it’s an issue many families need to consider, not just the very wealthy.

2. Giving away your assets means you won’t pay IHT on their value

You may have heard that gifting is one of the most common strategies for mitigating a potential IHT bill.

For example, you can use your “annual exemption” to gift up to £3,000 a year, and this sum will fall outside your estate for IHT purposes. You can also gift on the event of a wedding, gift small amounts up to £250, and gift from your income.

However, you should remember that other gifts you make may not immediately fall outside your estate, and that IHT may still be payable.

When you make a gift, it becomes a “potentially exempt transfer” (PET). This means that it will fall outside your estate, but only if you survive for seven years after making the gift.

So, if you make substantial gifts and die within seven years of making them, your estate could still be liable for IHT on the value of the gifts – albeit at a lower rate of IHT if you die between years four and seven.

Gifting can be a complex area, so seeking advice can help to make the most of this strategy.

3. You can gift a property to avoid paying IHT on it

Your house is likely to be the biggest asset you own. So, even though you can make use of the “residence nil-rate band”, if any IHT is due it’ll likely be on the value of your main residence.

So, gifting your home to family might appear to be a useful way of side-stepping a potential tax liability. However, there are two important issues to consider.

The seven-year rule

As you read above, if you gift your home and you die within seven years of making the gift, the value of the gift will likely be added into the IHT calculation.

You’ll have to pay rent if you remain in the property

If you gift a property, and you continue to derive a benefit from the property (for example, if you continue to live there) the value of the property will be subject to IHT at the date-of-death value.

If you stay in the property once you have gifted it, you will need to pay rent at the same rate as similar local rental properties and pay utility and other bills.

If you continue to live in the gifted property rent-free after you have transferred ownership, the property will not be exempt from IHT.

In addition, other taxes such as Stamp Duty and Capital Gains Tax (CGT) may apply to a gift of property, so seeking professional advice is important.

4. You don’t pay any UK IHT on assets you hold abroad

Many people with overseas assets believe that they are not liable for IHT in the UK on this foreign wealth.

However, if you live in (and are domiciled in) the UK, your entire estate worldwide is potentially taxable on your death regardless of where it is situated.

So, if you have a holiday home, or a bank account or investments overseas, your estate could be liable for IHT on these worldwide assets.

5. Everybody will pay some IHT

While more and more families are set to pay IHT on inherited estates over the coming years, it’s a myth that everybody will pay at least some IHT.

In 2019/20, only around 1 in 25 estates found themselves liable to the tax. Even as property prices and asset values rise, IHT affects a small proportion of estates – but that could easily be you without the right planning.

Bear in mind also that most estates will have to prove to HMRC there’s no IHT to pay before the distribution of assets can begin.

There is a range of strategies you can adopt to mitigate the IHT you may be liable for on death, to ensuring you use your nil-rate bands, to making the most of gifts.

To find out how we can help you, email us at helpme@aspirellp.co.uk or call 0117 9303510.

Please note

This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.

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