Death and taxes: The Autumn Budget and reform of inheritance tax

The new Prime Minister has made social care reform a priority for his government and he has not ruled out tax cuts to fund it. He can hardly afford to, with the costs of creating a National Care Service estimated to require additional spending of £18.5 billion annually and rising.

One option the government has been widely reported to be considering is a 10% “death tax” that would replace the inheritance tax regime. Wiping away the existing reliefs and allowances with a flat rate levied on all estates this would be likely to more than cover the costs. IHT raised £8.5 billion last year, but it is currently only paid on under 5% of estates. The vast majority fall below the threshold for paying thanks to the two main allowances:

• The nil rate band of £325,000

• The residential nil rate band (RNRB) for the main home of £175,000

Given that these can be transferred on the first death (as long as the surviving spouse is the beneficiary), many couples can currently pass on up to £1 million of assets free of IHT (or more if they own agricultural property or businesses).

It’s not the first time anyone has looked at reforming IHT. An all-party parliamentary group in 2020 suggested significant simplification and reform, including changes, such as the abolition of business property relief (BPR) and agricultural property relief (APR), that have been at least partly put into effect. This would be far the most radical change to date.

Taking the crude measure of the existing £1m reliefs and exemptions (and assuming transfers between spouses and civil partners remained exempt), a 10% flat rate would leave the majority worse off, but a couple leaving an estate of over about £1.35m better off, with the change cutting their bill of £140,000 under the existing regime by £5,000.

In practice, however, exactly who benefits most and by how much is slightly more complicated.

Fortunately, HMRC’s updated commentary on IHT liabilities published at the end of July offers a guide. The figures it uses are a little dated, as it takes the tax year ending April 2024, but it still provides useful insights.

These figures reiterate how few estates currently pay any inheritance tax: just 30,400 in 2023/24, representing 4.72% of UK deaths during that period (644,000).

Despite remaining low, this level is at its highest since a peak in 2006/2007 (5.96%). As the commentary notes, from 2017 to 2021 the proportion remained relatively flat, with the introduction and subsequent increases in the RNRB offset rising asset prices that would otherwise have dragged more estates into scope. However, RNRB reached £175,000 in the 2020 to 2021 tax year, where it remains, and each year since has seen the proportion paying IHT rise.

With both the nil rate band and RNRB frozen until April 2031 (beyond the current parliament), it will continue to rise anyway, even if IHT isn’t changed. The elimination of full APR and BPR and inclusion of unused pension funds in the value of estates from April 2027 will boost it further. But a flat 10% tax and elimination of the nil rate bands would have a far greater impact in widening the tax base.

One impact is that it would significantly reduce the average bill paid by estates, which was £231,000 in 2023/24. This has increased markedly since the introduction of the RNRB, which took many estates paying small amounts out of IHT altogether. A flat rate would reverse this – and then some.

It will also obviously decrease the rate paid by estates with assets significantly over the nil rate bands – but by how much will vary significantly.

While the rate of IHT is 40%, the nil rate band and RNRB mean this isn’t charged on the full value. In practice, the tax bill as a proportion of net assets – the average effective tax rate (AETR) – was 13% across all estates paying IHT in the 2023/24 tax year.

Within that average, though, there’s a considerable range. For the smallest estates paying IHT in 2023/24 – those with net assets between £300,000 and £400,000 – the AETR was 4%. There were only 2,300 of these in that year, and they paid an average of £13,800. Under the flat rate, there would be many more of them and they would pay at least £30,000 each.

The AETR then increases as the estates grows larger, as you’d expect:

• Reaching 12% for the 7,770 estates valued between £1 million and £1.5 million, which paid an average of £151,000 (£1,000 over the maximum this band would pay under a 10% flat rate)

• Rising to 19% for the 2,930 estates valued at more than £1.5 million but less than £2 million, who paid an average of £324,000 (against a maximum of just under £200,000 under the flat rate)

• And peaking at 25% for the 3,156 estates valued from £2m (at which point the RNRB is tapered away at £1 for every £2 over this sum) to £7.5m.

Average IHT paid in this last group ranged from £557,000 for those valued between £2m and £3m, up to £1.49m for those worth from £5m to £7.5m. A flat rate would see them pay as little as £200,000, to a limit of £750,000.

Curiously, above £7.5m the AETR has traditionally fallen for larger estates, down to 23% for those valued between £7.5m and £10m and 18% for those above £10m. This is explained by their proportionately greater use of reliefs such as business property relief (BPR), which after the spouse and civil partner exemption was the second largest relief set against assets for IHT purposes in 2023/24.

Together, BPR and agricultural property relief were claimed against £5.96bn of assets in that tax year, compared with IHT liabilities of £7.03bn. Even so, however, the 364 estates within these two highest tax bands paid big bills: average IHT of £1.99m and £4.72m respectively.

Estates in these bands would therefore also see huge savings under a flat 10% rate – and many of them even more so going forward given the restrictions on APR and BPR from April 2026, which limited full relief to the first £2.5m of assets (or £5m for a couple).

And this is probably why a simple flat rate death tax seems unlikely. IHT is already wildly unpopular – the most disliked tax, according to surveys, with 54% in a poll commissioned by the Financial Times last year wanting it entirely abolished. And that’s mostly people who won’t pay it. It’s hard to see that imposing it universally, even at a lower rate, while at the same time giving an effective tax cut to the wealthiest estates, would go down well.

There are no easy ways to raise tens of billions, and arguably few popular choices. A flat rate death tax, though, has the potential to see some very big winners but a lot of losers. One suspects it could be considered a step too far for the new Prime Minister and Chancellor.

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