Why did UK chancellor Rachel Reeves not hike the inheritance tax (IHT) rate as part of her multi-billion-pound tax-raising Budget in autumn 2025?
Most likely because she did not have to. Rising asset prices, frozen allowances and the tendency for individuals not to take legitimate mitigating action, such as gifting, all have the same effect as raising the headline tax rate — an increase in the government’s IHT tax take.
IHT is forecast to bring £9.1bn into the UK Treasury’s coffers in 2025-26, according to The Office for Budget Responsibility (OBR), a significant 21% increase from the £7.5bn in 2023-2024. And the OBR expects the overall IHT take will reach £14.3bn in 2029/2030, far and above the £2bn raised in 1999-2000.
It’s not hard to see why IHT receipts are forecast to keep rising, due to:
The hard truth is, HMRC is not just a shadow beneficiary. It will also likely be among the biggest beneficiaries too.
To see how this could happen, take Mrs A, a 76-year-old divorcee. Mrs A has an estate worth £1m comprising a house (£300,000), pension (£450,000) and investments (£250,000). Her two children, both of whom are higher rate taxpayers on £51,000 annual salaries, will inherit her estate equally. For illustrative purposes only.
Mrs A does not make any gifts to her children during her lifetime. So, if Mrs A were to pass away in 2026 then, once the nil-rate (£325,000) and residence nil-rate bands (£175,000) are applied and the pension (£450,000) stripped out, £50,000 of the estate would be liable to IHT at 40%, equating to a £20,000 tax bill.
But because Mrs A is over 75, income tax will be charged on the residual pension pot, in this case at an effective pension rate of 43.35%, equating to an additional tax bill of £195,086.
As the bill is shared equally between Mrs A’s children (£97,543 each), the final estate split is £392,457 to each child, with £215,086 (21.5% of the estate) being inherited by HMRC. It is also worth noting that the pension value will have pushed both beneficiaries here into the additional rate tax band.
From April 2027, unused pensions pots will be included in a deceased person’s estate for IHT purposes. As pensions will still be liable to income tax, they will potentially be subject to double taxation.
So were Mrs A to survive post-April 2027, her £450,000 pension would be included in IHT bill calculations so that once the nil-rate (£325,000) and residence nil-rate bands (£175,000) are applied, £500,000 (as opposed to £50,000) of the estate would now be liable to IHT, resulting in a £200,000 tax bill.
Applying the pension’s share of the overall estate (45%) to the nil-rate band equates to £146,250 (£325,000 x 45%). This is the IHT-free element of the pension, leaving £303,750 subject to IHT at 40%. Out of the overall estate’s £200,000 IHT liability, £121,500 is therefore apportioned to the pension.
But the children will still have to pay income tax on the pension. Subtracting the £121,500 IHT pension bill from the value of the pension leaves £328,500 upon which income tax will be due. This sum is split equally between the son and daughter (£164,250 each). Each child’s share of the pension is taxed giving a total income tax bill of £140,411 (£70,205.5 each). The total tax paid on the pension is therefore £262,911 (£121,500 IHT + £140,411 income tax) or 58.2% of the pension value. Once again, both children’s tax rates will be pushed into the additional rate tax band due to their existing income of £51,000.
This leaves the final beneficiary split at £329,794 per child and £340,411 for HMRC. At 34.04%, HMRC’s share of Mrs A’s estate would be the largest.
While little can be done about rising asset prices (not that anyone would necessarily want to do anything about this) or frozen allowances, something can be done about the third leg contributing to rising IHT bills — inaction. By planning and taking effective action we can deprive the shadow beneficiary of any inheritance from the estate.
Gifting is one such action that can be taken to reduce a potential IHT liability and includes:
Several of the exempt transfers are on the small side if looked at individually:
But taken together they can make a meaningful impact on lowering future IHT bills.
Back to Mrs A. Making full use of the annual exemption and gifting £3,000 to her two children would save £1,200 in IHT. And because Mrs A has never gifted before she can use the previous year’s unutilised allowance to make a combined £6,000 gift, resulting in a £2,400 IHT saving. Giving £250 to six other people (grand/godchildren) saves a further £900. Already, an IHT saving of £3,300 has been made in just the first year of gifting.
Small numbers on their own. But taken together and repeated each year, a sizeable dent can soon be made to any future IHT tax bill.
How many people understand what gifts are available and how they work, let alone nil-rate band transfers, taper relief or the near 100 tax reliefs that can legitimately reduce IHT? Chances are not many. The government does not need to raise the IHT tax rate to generate more revenues, as lack of awareness (and confusion) does the work for them. Planning windows therefore get missed, gifting starts too late in life (if at all) to make a real difference, and HMRC’s tax take increases.
Enter financial advisers. Working with clients, financial advisers can not only shine a light on the shadow beneficiary of deceased estates but, using their knowledge and expertise, they can also help draw up an effective plan and strategy to ensure HMRC does not end up being the biggest beneficiary of them all.
Investments and the income from them can go down as well as up, you may not get back what you invest.
This material is not tax, legal or accounting advice and should not be relied on for tax, legal or accounting purposes. Quilter Cheviot Limited does not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting adviser(s) before engaging in any transaction.
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The value of your investments and the income from them can fall and you may not recover what you invested.
