How Reeves’s inheritance tax changes will affect families

The Autumn Budget might be two months away, but speculation over which taxes the Chancellor will increase has already begun. Rachel Reeves is constrained by her manifesto pledges to keep income tax, VAT and National Insurance at the same level, despite calls to ‘substantially’ increase taxes.

She is reportedly eyeing further changes to inheritance tax (IHT), less than a year after she announced plans to charge the tax on inherited pensions from April 2027. One of her options is to impose a lifetime gifting allowance, which would hit those who try to avoid IHT by giving away money and assets to their family before they die. Why is IHT reform on the cards again, what could Reeves’ plans entail – and what does it mean for you?

IHT has historically only affected the very wealthy. At the moment, just 4 per cent of estates pay it. That is set to rise because house prices are increasing, while the threshold over which people pay inheritance tax stays the same. IHT being levied on private pensions left to descendants from 2027 will drive a further increase. Since 2009, an individual has needed to be worth £325,000 if you are single, or £650,000 if married or in a civil partnership, for beneficiaries to incur any death duties. This allowance is known as the nil-rate band.

If you are married, own a property and leave your main home to direct descendants (children or grandchildren) you each get a further £175,000 allowance, known as the residence nil rate band. Collectively, it means a couple that meet this criteria could pass on £1million tax-free. The £325,000 nil rate band has been unchanged for 16 years, which means that rising property prices have dragged more people into paying IHT. Had it risen in line with inflation, it would be £585,996, meaning fewer people would be affected.

There are some ways to minimise the amount of IHT paid, by gifting money to beneficiaries while you are still alive. You can gift £3,000 a year, and unlimited small gifts of up to £250, free from tax. However, if you die less than seven years after making the gift then you will start to pay IHT. This is levied on a sliding scale, from 8 per cent if gifts were made 6-7 years before death, to 40 per cent, if made within a year. This rule is designed to stop people making large gifts to family just before they die, in a bid to avoid IHT. Like the nil rate band, the gifting allowance has not changed since its introduction in 1986. If it had risen in line with inflation, it would be quadruple its current level at £12,297. As more people gift cash or assets to beneficiaries, they are more likely to fall foul of the rules.

Financial advisers tell This Is Money there has been a significant behaviour shift among their clients. More individuals are gifting their money to children and grandchildren to minimise their inheritance tax burden ahead of the pension changes in 2027. However, figures show that most people are not paying tax on their gifts, even if the giver has died within seven years. This is because you can actually gift far more than the £3,000 gifting allowance, so long as it doesn’t breach the £325,000 nil rate band. These gifts will form part of your estate – but if it is below that threshold, you still won’t pay tax. For example, if you have very few assets and you gift £10,000, and remain within the nil rate band, your estate will not pay tax on it. It means that it’s very difficult to know how many people are gifting money tax-free, and likely why Reeves is eyeing changes to the rules.

A Freedom of Information request by This Is Money shows the number of families that are taxed on gifting was relatively low in the three years to 2021-22, the latest figures available. The figures have remained stable, with around 1,000 families being stung by IHT on their gifts each year, but some advisers suspect this doesn’t paint the full picture. ‘There will be people who gift and die within 7 years and then it’s clawed back from the nil rate band, which don’t appear in the figures,’ says Lisa Caplan, director of advice and guidance at Charles Stanley. Shaun Moore, tax and financial planning expert at Quilter, also suspects ‘people are gifting within the allowances and not suffering tax on the gifts.’ For example, a gift of £250,000 wouldn’t appear in the gifting table, but the estate will pay the tax because they’ve lost that amount from the nil rate band. Caplan predicts that the number of people who fall into the ‘gfiting trap’ will be higher as more people take out their tax-free cash early and start the…