Rachel Reeves is coming after pensions with inheritance tax. (Image: GETTY)
Last week brought home just how big a threat inheritance tax is these days, as new figures show the Treasury now takes record amounts of people’s money when they die.
Britons paid £8.5billion in inheritance tax (IHT) in 2024/25, up almost 50% in just four years. And it won’t stop there. The bill is forecast to hit £15 billion by the end of the decade, a rise of more than 75%.
Of course, IHT isn’t the only threat, as first the Tories and now Labour Chancellor Rachel Reeves keep hiking taxes. Sarah Coles, head of personal finance at AJ Bell, said HMRC is carving up an ever-thicker slice of people’s earnings, savings, investments and wealth.
The freeze on income tax thresholds, announced in 2021, now runs through 2031 thanks to Reeves. Incredibly, the £325,000 IHT nil-rate band has been frozen since 2009 and will remain so until 2031. If it had risen with inflation, it would be worth £528,431 today. If inflation averages 3%, that would rise to £612,596 by the end of the freeze.
Coles said IHT bills are climbing relentlessly as a result. “Rising house prices and investment values have pushed more estates into paying this tax every year, and driven up bills for anyone caught in the net.”
As if that wasn’t enough, Reeves will impose IHT on unused defined contribution pensions from April 6, 2027. “Around 38,500 estates will pay more than they would have done otherwise, with their average liability rising by £34,000 to £203,000.”
People have never liked IHT. It’s been voted the UK’s most unpopular levy. But now there’s a real reason to be angry, and to fight back. But what can you do?
Add it up
First, beware complex tax avoidance schemes. They could unravel, and cost far more than they were ever likely to save.
With careful planning, a married couple can use both their £325,000 nil-rate band and £175,000 main residence allowance, which applies when passing on family homes to children. Done properly, they could pass on £1 million in total. A decent start.
Start by totalling the likely value of your home, pensions, investments, savings and other assets, including cars, jewellery, furniture, art and antiques. If you’re under £1 million today and likely to remain there, you can breathe a little easier. But if you’re in the danger zone, it’s time to plan.
A drag
IHT gifting allowances have also been frozen for years. The annual £3,000 gift exemption was originally introduced in 1981. If it had risen with inflation, it would be worth around £11,785 today.
You should still use it, though. Everyone can also give smaller gifts of up to £250 a year to as many as they like.
Larger transfers, known as potentially exempt transfers (PETs), fall out of your estate if you live seven years after making them. Within that period, the 40% charge tapers on a sliding scale. Coles warned: “Don’t be in a rush to give away too much too soon, or you could face a shortfall later in life.”
Lisa Caplan, director of Charles Stanley Direct Advice, suggested using the tax-exempt “gifts out of surplus income” rule. “You can make any number of small, regular gifts provided they do not affect your lifestyle.”
These must come from income, not capital. “This requires good record keeping to demonstrate when the gifts were made and that they were genuinely from income.”
Pensions
Many families have been building wealth and pensions with the aim of passing them on free of IHT. Reeves has put a stop to that. From next April, unused pensions could be subject to IHT at 40%. If the policyholder dies after age 75, beneficiaries may face an income tax bill, too, which could exceed 60%.
Simply withdrawing the money and spending it is one option, but withdrawals are added to income and may be taxed. Higher rate taxpayers face 40%, although those earning below the £50,270 threshold pay 20%.
They could invest the money on behalf of children, for example, in a Self-Invested Personal Pension (SIPP). Families can invest £3,600 a year per child and claim 20% tax relief. That would soften the blow of income tax on pension withdrawals.
Alternatively, up to £9,000 a year can go into a Junior ISA for the under-18s. There’s no upfront relief, but all future returns are tax-free.
Caplan said doing nothing is no longer an option. “Funding the next generation’s pension or ISA can allow your family to benefit when they need it most.”
Trusts
Reeves’s pensions IHT move could also make setting up a trust more attractive, but they’re not a silver bullet, Caplan said. “They require care, foresight and expertise. Otherwise, the cost can outweigh the benefit, or there can be a loss of flexibility for little gain.”
Other options include whole-of-life insurance written into trust, so loved ones receive a payout on death, free of IHT. The catch is that you must commit to paying premiums for life.
Alternatively, annuities pay a guaranteed income for life. Rates are at their highest for years, and with no money left on death, there’s no IHT bill either.
IHT planning can be complex and costly, but expert advice can save far more than it costs in the long run.