Income Tax Threshold Freezes and Rising House Prices Push Middle-Class Families into Inheritance Tax 'Trap'
- TBA
- 5 days ago
- 5 min read
Inheritance tax (IHT) is quietly becoming an important source of government revenue growth. What is truly worth noting is that an increasing number of ordinary families who are not usually considered 'wealthy' are being brought into the tax scope.
Following the release of the Spring Budget earlier this year, the UK Office for Budget Responsibility (OBR) announced that the forecast for Inheritance Tax receipts over the next five years will be revised upwards by £700 million.
During the period from 2025/26 to 2030/31, the Treasury expects to collect £70.6 billion in Inheritance Tax. Meanwhile, a key policy adjustment is approaching – pensions will officially be included within the scope of Inheritance Tax.
What kind of chain reaction will this bring?
Key changes: pensions to be included in Inheritance Tax
According to data published by the OBR, annual Inheritance Tax receipts are expected to grow from this year's £8.7 billion to £14.7 billion in 2030/31.
In 2027/28 alone, receipts will increase by £100 million, and thereafter, an additional £200 million will be added each year until 2030/31.
There is no doubt that Inheritance Tax is becoming increasingly lucrative as a tax target.
One of the core reasons for this is that a major change is about to occur in pension policy – Chancellor of the Exchequer Rachel Reeves announced in the 2024 budget that from April 2027, pension pots will be brought into the Inheritance Tax net.
For a long time, pensions have been viewed as a highly efficient wealth transfer tool.
This is because they can usually be arranged outside the Inheritance Tax framework to reduce the amount of tax payable. However, following the policy change, many families who originally relied on pensions for asset transfer will see more of their assets fall under the 40% Inheritance Tax rate.
This also means that by the end of this decade, the total value of estates will more easily breach the tax-free threshold. This tax is no longer confined to ultra-high-net-worth individuals but is gradually expanding to the middle class. People who originally did not need to pay tax may start receiving tax bills.
Double tax burden: middle-class families become taxpayers
In addition to the pension policy changes, another driving factor is the long-term freeze on Inheritance Tax thresholds, coupled with continuously rising asset prices.
Rising house prices, in particular, are causing the total assets of an increasing number of families to cross the key thresholds. The OBR expects that by 2030/31, there will be over 16,000 estates valued at more than £2 million. In 2022/23, only 3,620 estates liable for Inheritance Tax exceeded this level.
More notably, once the total value of an estate exceeds £2 million, the residence nil-rate band will be gradually tapered. This additional £175,000 tax-free allowance will decrease at a rate of '£1 for every £2' above the threshold.
For an individual, this allowance will completely disappear when the total estate reaches £2.35 million; for couples, it cannot be used once the estate reaches £2.7 million. This little-known 'tax trap' is causing more families to inadvertently lose the tax-free space they could have enjoyed.
A 'triple blow' is forming
A slight move in one part affects the whole situation.
Bringing pensions into the scope of Inheritance Tax may lead to a 'triple blow': firstly, the pension itself is taxed; secondly, the family residence nil-rate band may be lost; and thirdly, beneficiaries may also face an income tax burden.
Here are a few examples to illustrate the effect:
If an unmarried person has £20,000 in savings, a £290,000 home, and a £145,000 pension, they might currently not need to pay Inheritance Tax. However, from April 2027 onwards, their tax bill could reach approximately £52,000.
If a married couple has a £500,000 home, £100,000 in cash, £200,000 in ISA accounts, and a £400,000 pension, upon the death of the second spouse, they could face an Inheritance Tax burden of approximately £80,000.
These figures show that the impact of Inheritance Tax is significantly expanding, and the shock is particularly pronounced for families with a high proportion of pensions in their asset structure. The magnitude of the tax leap is enough to alter the wealth planning arrangements of many families.
Tax relief?
Finally, let us take a look at the current Inheritance Tax rates and relevant reliefs.
Usually, Inheritance Tax is not payable in the following two situations:
The total value of the estate is below the £325,000 tax-free threshold;
Any part exceeding the £325,000 threshold is left entirely to a spouse, civil partner, charity, or community amateur sports club.
If the main residence is left to children (including adopted, foster, or stepchildren) or grandchildren, the tax-free threshold can increase to £500,000. For married individuals or those in a civil partnership, if one party's estate is below their personal tax-free threshold when they pass away, the unused allowance can be transferred to the surviving spouse or partner and used together upon their death.
Inheritance tax on the estate exceeding the tax-free threshold will be taxed at the standard rate of 40%. Even if the value of the estate is below the threshold, it may still be necessary to report the total estate value to HM Revenue and Customs (HMRC).
Furthermore, some assets gifted during one's lifetime may still be subject to Inheritance Tax after death. For example, if the gifted amount exceeds £325,000 and the donor dies within 7 years, the recipient may need to pay tax.
Depending on the timing of the gift, 'taper relief' may apply, reducing the actual tax rate to below 40%. In addition, certain relief policies (such as Business Relief) allow some assets to be exempt from Inheritance Tax or benefit from a lower tax rate. If the estate includes a farm or woodland, you can also enquire about Agricultural Relief policies.
It is worth noting that Inheritance Tax is usually paid from the funds of the estate itself, rather than borne personally by the heirs. The person responsible for dealing with the estate (known as the 'executor' if there is a will) needs to pay the tax to HMRC on behalf of the estate.
Generally, heirs do not need to pay Inheritance Tax on the inherited assets themselves, but if the inherited assets generate income, such as rental income from an inherited property, they may need to pay corresponding income tax.
The view from TB Accountants
Bringing pensions into Inheritance Tax from April 2027 will truly change the landscape. Rising asset values and outdated tax thresholds will together create a perfect storm.
More families will be caught in the tax net completely unprepared, and many will unwittingly enter it, even if they have never considered themselves 'wealthy'.
In the future, Inheritance Tax will no longer be just a 'tax on the rich'.
For an increasing number of middle-class families, estate planning will shift from being optional to mandatory. We recommend that you assess your asset situation promptly, including obtaining updated valuations for properties, to understand the potential Inheritance Tax risks you may face.
Of course, estate planning itself is quite complex. Professional financial advice can help you structure your assets more efficiently, retaining maximum wealth for your family while remaining legally compliant.
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