The tax could soon become a common bill for the middle class, not just the wealthy, as experts raise the alarm
UK households could soon be facing a new tax trap. Fewer than one in 20 estates were liable for inheritance tax in 2022, with just 4.62% of deaths resulting in an inheritance large enough to trigger a tax bill.
However, experts are raising the alarm as a combination of frozen thresholds and changing liability could soon see the middle class facing these 40% tax bills. Eamonn Prendergast, Chartered Financial Adviser at Palantir Financial Planning Ltd, said: “Inheritance tax is fast becoming the great middle-class trap. In London especially, ordinary families who simply bought and stayed in their homes for decades now find themselves facing six-figure tax bills.
“The £2 million taper threshold for the Residence Nil Rate Band hasn’t moved in years, while house prices have surged and allowances remain frozen until 2030. Add in the potential inclusion of pensions from 2027, and thousands more estates will be pushed over the line not through excess wealth, but through inflation and inaction. The rules were designed to target the very rich, but in today’s housing market they’re catching families who never saw themselves as wealthy at all.”
Experts are urging people who may have never considered themselves wealthy enough to trigger an inheritance tax bill to start educating themselves on the topic as they may become liable without even realising it. There are a number of thresholds that can make certain parts of an estate exempt from Inheritance Tax.
Usually, there’s no inheritance tax due on estates valued below £325,000, known as the nil rate band, or if everything above this value is left to a spouse, civil partner, a charity or a community amateur sports club. This threshold can be increased by £175,000 if their home is part of the estate – this is known as the Residence Nil Rate Band.
However, there is also the residence nil-rate band taper, which reduces the threshold by £1 for every £2 that the estate is worth over £2million. While a £2million threshold may sound unreachable to some middle class families, those living in areas like London may face an unexpected reality as homes now worth around £658,000 on average could put an estate above this limit.
These thresholds are also all frozen until 2030. With inflation, rising house prices potentially pushing up and most recently certain pension pots becoming liable for inheritance tax from 2027, estate values will continue to rise while thresholds remain still.
Rob Mansfield, Independent Financial Advisor at Rootes Wealth Management, said: “This is a ticking time bomb and the government will be rubbing their hands at the prospect of greater inheritance tax receipts. If they keep freezing the thresholds and don’t build enough homes, property prices in London and the south east alone will eat up most of the allowances and so people who have undertaken sensible planning are going to be caught up.
“For some people, I don’t think it has fully sunk in that any money left in a pension will soon form part of their inheritance tax calculation. It’s particularly invidious that there’s no allowance for a premature death before pension access is even possible.”
Antonia Medlicott, Founder & MD at Investing Insiders, added: “The average UK pension pot is now worth around £250,000. If the government presses ahead with including unused pensions in IHT calculations, tens of thousands of families will be hit with IHT bills for the first time.
“These are families who will be blindsided by debt on what we previously would have called a ‘modest inheritance’. I’m also worried about the effect this will have on the public’s appetite for pensions.
“At a time when we’re constantly being warned by experts that we’re heading towards a pensions crisis, with far too few of us saving enough, this is giving terrible mixed messages. It’s certainly a strange way to encourage younger people to see the benefits of saving.”
In a recent statement about possible changes to inheritance tax in the Budget, the Treasury told the Guardian: “As set out in the plan for change, the best way to strengthen public finances is by growing the economy – which is our focus. Changes to tax and spend policy are not the only ways of doing this, as seen with our planning reforms, which are expected to grow the economy by £6.8bn and cut borrowing by £3.4bn.
“We are committed to keeping taxes for working people as low as possible, which is why at last autumn’s budget we protected working people’s payslips and kept our promise not to raise the basic, higher or additional rates of income tax, employee national insurance or VAT.”
