Fight back now as HMRC wages ‘fiendish’ IHT war – secret weapon slashes tax bills

Inheritance tax explained by Interactive Investor expert

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The Government raked in a record £6.1 billion from IHT in the last financial year, easily the largest total ever. This is part of a wider war on taxpayers, that has driven the tax burden to the highest level in 70 years.

The amount Britons pay in IHT is accelerating, with receipts jumping 14 percent in the 2021/22 tax year.

It will only increase due to former Chancellor Rishi Sunak’s five-year freeze on tax thresholds, which will not increase until 2026 at the earliest.

The nil-rate threshold for paying inheritance tax has been frozen at £325,000 since 2009, while house prices and markets have grown strongly in that time.

Halifax says the average home across the UK now costs £293,211, just under the threshold, so millions now risk paying this tax.

With house price growth remaining strong despite the looming recession, up 11.8 percent in the last year, more will get pushed into the IHT net.

You do not have to be super wealthy to pay this tax, as the value of all your assets are totalled up on death, and count towards any IHT liability.

There is one major exception, though.

Pensions are usually IHT-free on death and can be passed on tax-free to beneficiaries if you die before age 75, says Tom Selby, head of retirement policy at AJ Bell.

As well as the main nil-rate band of £325,000, families also benefit from the residence nil-rate band, which allows them to pass on a further £175,000 of value from their main home.

However, this only applies where direct descendants inherit the property, such as children and grandchildren.

It can increase the total you can pass on to £500,000. Married couples and civil partners can combine their allowances and pass on £1 million free of IHT, but only if they plan carefully.

Tens of thousands fail to maximise their inheritance tax planning opportunities, because the system is “fiendishly complicated”, Selby says.

Many fail to realise they could pass on more wealth by using a secret IHT planning weapon – their pension savings. “When it comes to your long-term savings, pensions are now extremely tax efficient on death,” Selby says.

There is usually no IHT to pay on inherited pensions. “It is possible to pass on your pot entirely tax-free to your nominated beneficiaries if you die before age 75.”

If you die after age 75, the inherited pension will be taxed in the same way as income when your beneficiary comes to make a withdrawal, Selby adds. There is no IHT to pay, though.

Unlike other investments, including savings accounts and supposedly tax-free Isas, your pensions do not form part of your taxable estate.

That makes it tax-efficient to keep your savings in a pension fund and use other savings and investments to fund your income in retirement, if you can.

“It could help you pass on even more of your wealth to future generations,” Selby says.

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Naturally, this option will not be open to everybody. Most pensioners need to use every penny of their retirement savings to make ends meet as the cost of living rockets.

It is still important to know what you can and can’t do to ease your IHT liability, though. “If passing money onto loved ones is important to you, review where your assets are held to ensure you aren’t exposing more than is necessary to IHT,” Selby says.

He adds: “This can be a fiendishly complicated area of financial planning, so it’s worth considering speaking to a qualified financial adviser to understand your options. You will need to pay a fee for their services, but often their expertise in navigating the tax maze may save you and your beneficiaries much more.

“This will help keep more of your hard-earned assets out of the claws of the taxman.”

Becky O’Connor, head of pensions and savings at Interactive Investor, added: “There are other ways to reduce your IHT liability, such as careful use of gifting.”

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