Why rising house prices could mean you need to reconsider your Inheritance Tax plan

House prices have reached record highs this year. While you may be pleased the value of your home is increasing, it may also mean you now need to consider Inheritance Tax (IHT). Or if IHT already plays a role in your plans, they may need updating.

A combination of rising demand, the Stamp Duty holiday, and 5% mortgage guarantees to support first-time buyers means house prices have reached new highs. According to the Halifax House Price Index, the average house price in June 2021 was £260,358. That’s 8.8% higher, the equivalent of £21,000 more than 12 months earlier.

The rise in house prices now means that your property alone could take up a significant portion of your IHT allowance and may mean your loved ones face an unexpected bill when you pass away. With a standard tax rate of 40%, IHT can have a huge impact on your estate and what you leave behind. There are often things you can do to reduce an IHT bill, but you will need to take these steps before you pass away.

It’s normal to approach estate planning with some trepidation, but it can ensure your wishes are followed and your pass on your wealth to family, friends, and others that are important to you.

When do you need to consider Inheritance Tax?

According to the Financial Times, HMRC collected £5.2 billion in IHT in 2019/20. While it’s something only around 5% of families need to consider, house prices rising faster than inflation may mean more estates will be liable to IHT in the coming years. It’s important to understand it’s something that could affect you.

Most estates will benefit from two allowances:

  • The first is the nil-rate band, which is £325,000 for the 2021/22 tax year. If the value of all your assets is below this threshold, your estate will not be liable for IHT.
  • If you’re leaving your main home to children or grandchildren, you can also use the residence-nil rate band, which will increase your threshold by £175,000 in 2021/22.

As a result, you can usually pass on up to £500,000 without needing to consider IHT.

Any unused allowance can also be passed on to a spouse or civil partner. In effect, this allows couples to pass on up to £1 million before IHT is due. That can sound like a lot, but soaring house prices mean the average property eats up more than a quarter of this allowance. If you live in a more expensive region or your property is above the average national price, IHT could affect how your estate is distributed.

It’s an issue that’s likely to affect more families in the future too. It’s expected that the IHT allowances will increase each tax year by the rate of inflation. Currently, house price rises are far outstripping inflation, which the Bank of England aims to keep below 2% a year.

Easing of the Covid-19 lockdown means inflation in the 12 months to June 2021 was higher than expected at 2.4%, according to the Office for National Statistics. Even this higher-than-expected figure is much lower than the 8.8% rise house prices experienced. If the trend continues, property will take up more of your IHT allowance, so it’s essential you keep this in mind when planning your estate.

5 steps you can take to reduce an Inheritance Tax bill

1. Write a will

Writing a will is the only way to ensure your wishes are carried out. It’s also an important step when making full use of your allowances. For instance, naming your children or grandchildren as beneficiaries of your main home ensures you can make use of the residence nil-rate band.

2. Place some of your assets in a trust

In some cases, placing assets in a trust means they do not form part of your estate when calculating IHT. It is possible to still receive an income from these assets. However, this isn’t always the case, and forming a trust can be complex. It’s important you take legal and financial advice if you’re thinking about using a trust.

3. Gift during your lifetime

While leaving an inheritance is the traditional way to pass on wealth, you can also provide gifts to loved ones during your lifetime. This can reduce the value of your estate while your loved ones benefit. However, keep in mind that some gifts will be considered part of your estate for IHT purposes for up to seven years. To discuss what gifts are considered immediately outside of your estate, please contact us.

4. Leave something to charity

Passing on some of your wealth to charity can support organisations that are important to you, but it can also help you reduce an IHT bill. Providing a charitable gift may mean your estate comes under the IHT threshold, so your estate doesn’t face a bill. You can also reduce the IHT rate from 40% to 36% by leaving at least 10% of your entire estate to charitable causes.

5. Keep your estate value below the thresholds by spending

Finally, spending some of your wealth to fund your retirement or later years can keep the value of your estate below thresholds so no IHT is due. Splurging on a holiday or updating your home can mean you enjoy retirement more and avoid an IHT bill.

Depending on your circumstances and goals, there may be other steps you can take to reduce an IHT bill. You may also want to explore ways that an IHT bill can be paid for. A life insurance policy written in trust, for example, can provide loved ones with a lump sum to pay the bill. This leaves your estate intact to pass on how you wish.

If you’d like to discuss IHT and whether rising house prices mean it would be valuable for you to consider, please get in touch.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The Financial Conduct Authority does not regulate estate or tax planning.

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