A third of Britons over the age of 55 have no firm plans for how they will pass on their wealth to friends or family after they die, despite wanting to do so.
Research conducted by Fidelity International also found that half of Britons were either unclear about, or had never heard of, the inheritance tax ‘seven-year rule’ – even though it could potentially make their beneficiaries exempt from the levy.
The rule enables a gift of money, property or other assets to become exempt from inheritance tax (IHT) if the person giving it lives for seven years afterwards.
A fifth of those intending to leave an inheritance are concerned about not understanding the amount of inheritance tax they might have to pay, or how to manage it efficiently
This is a fundamental concept for any person planning to pass on wealth to the next generation, particularly if their estate exceeds the current IHT threshold.
Two thirds of those aged 55 or over intend to leave an inheritance to friends and family members, according to Fidelity.
However, almost a fifth of those intending to leave an inheritance said they did not understand the amount of tax they might have to pay, or how to manage it efficiently.
This is Money explains how inheritance tax works, and what people need to know when considering how best to pass on their assets.
What is inheritance tax charged on?
Inheritance tax is a tax on the estate of someone who has died, including their property, possessions and money.
It is usually charged at 40 per cent on anything above the nil-rate band allowance.
The standard nil-rate band is £325,000 per individual. However, there are a few ways to increase your allowance.
First, any unused element of a deceased person’s IHT allowance can be passed on to a spouse or civil partner – potentially taking their limit all the way up to £650,000.
Second, if a married couple or a couple in a civil partnership give away their main family home to their direct descendants, their limit is increased to a total of £500,000 each, or £1million combined. This is known as ‘main residence relief’.
Confusion: According to Fidelity, almost a fifth of those intending to leave an inheritance were concerned they did not understand the amount of tax they might have to pay
However, if the total value of an estate is worth £2million or more, the additional main residence relief will be tapered at £1 for every £2 over the £2million threshold.
This means some higher-value estates eventually lose the benefit altogether.
How much is the typical inheritance?
The average inheritance received in the UK is currently worth £70,639.
Even if someone was leaving that amount to all of their four children, it would still be well below the £325,000 limit for IHT.
But while the tax is only paid by a small amount of estates right now, the amount taken in by the taxman has nearly doubled in a decade, from £2.9 billion in 2011/12 to £5.33 billion in 2020/21.
Recent decades have seen more families caught in the inheritance tax net, as rising property prices push more homes over the limit.
And with the Chancellor, Rishi Sunak freezing the inheritance tax thresholds at current rates until 2026 it means a growing number of people will be swept up in paying the tax.
Some analysts suggest that in future as many as one in ten estates could end up paying 40 per cent tax on some of the wealth they have passed on.
What does the seven-year rule apply to?
In most cases, the seven-year rule applies to any gifts that are above an individual’s annual gifting allowance.
This is usually £3,000, although if unused it can roll over once, giving them a £6,000 limit.
|Years between gift and death||Tax paid|
|Less than 3||40%|
|3 to 4||32%|
|4 to 5||24%|
|5 to 6||16%|
|6 to 7||8%|
|7 or more||0%|
For IHT purposes, gifts over these allowances are known as potentially exempt transfers.
If they are within the person’s £325,000 allowance when they die, nothing needs to be done.
But if the person has exceeded that allowance by the time they die, the gift will only be free of inheritance tax if the person gifting survived more than seven years after making it.
If someone dies between three and seven years after making a gift, the inheritance tax due is tapered down on a sliding scale.
For example, the tax burden falls from 40 to 32 per cent if someone lives for three years after making a gift, and from 32 to 24 per cent if they survive for four years.
Dawn Mealing, head of advice policy and development at Fidelity International, said: ‘Our research highlights a real issue with inheritance planning in the fact many people are confused about how to get started.
Fidelity’s research also found that only 12 per cent of those aged 55 and over had discussed inheritance planning with a financial adviser, and only three fifths had created a will
‘Consumers said they felt the rules and regulations are confusing, and it’s concerning to see a third of those approaching retirement having no concrete plans for passing on their wealth.
‘Ultimately, this could mean that they have much less to leave their loved ones than they would like.’
Do all inheritances have to be reported to the taxman?
Fidelity’s research also suggested that many Britons may be needlessly worrying about the need to report inheritances they receive to HMRC.
Up until now, roughly 275,000 of the average 570,000 deaths a year resulted in inheritance tax forms needing to be submitted with the value of the estate reported to HMRC, even when there were no tax liabilities.
This was despite fewer than 25,000 bereaved families a year being liable for inheritance tax, which represents 5 per cent of all deaths, according to the Office of Tax Simplification.
But new rules are coming in from January 2022 which will mean that nine in ten estates that are not subject to inheritance tax will no longer need to complete the forms.
Fidelity found that as many as 85 per cent of those aged 55 or over were unaware of the new rules.
|Tax year||Government inheritance tax receipts (£billion)|
|Source: HMRC / NFU Mutual|
How can you pay less?
If inheritance tax worries you, you may wish to give your family gifts during your lifetime rather than leaving it all in your will.
Not only does it have tax benefits, it also means you get to see them enjoy their gifts while you’re still around.
You get a gift allowance of £3,000 each year that falls out of your estate immediately for inheritance tax purposes.
You can also make small gifts of up to £250, specific gifts for family weddings and unlimited regular gifts from income.
As for those who need to reduce or avoid a large inheritance tax bill, we have previously compiled a round-up of ways to do so, some of which can be undertaken easily by any ordinary person without the need for convoluted arrangements or to pay for professional help.
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