Four in five don't understand inheritance tax - and pension raid will make things worse

 Nearly four in five people don't know how inheritance tax works or what their loved ones may have to pay, research shows.

While 77 per cent are familiar with inheritance tax as a concept, the vast majority of these have no knowledge of what it will mean for them, according to a survey by Schroders Personal Wealth.

However, with inheritance tax thresholds frozen until 2030, and pensions set to be dragged into inheritance tax calculations from 2027, an increasing number will be set to pay inheritance tax in the coming years.

Already, HMRC figures show that inheritance tax receipts continue to hit record highs, most recently rising to £8.2billion from April 2024 to March 2025, £800million more than the same period a year before.

Alex Gaita, financial planning director at Schroders Personal Wealth, said: 'Getting our financial affairs in order is something many of us put off, but it becomes increasingly important as we think about the future.'

Inheritance tax is currently charged at 40 per cent on an individual's estate over the £325,000 inheritance tax threshold, with an additional £175,000 allowance for those who pass their own home on to a direct descendent. We explain more below.

In reality, only a small percentage of households pay inheritance tax – currently 4 per cent – as the total threshold for the levy can be increased to up to £1million for a married couple once the own home allowance is added.

However, the number paying the tax is expected to increase to around 8 per cent once pensions are included.

And this could continue to accelerate in the years ahead, as while inheritance tax limits have been frozen, house prices have been rising and those who have spent their working lives saving into defined contribution pensions are building bigger pots. 

Yet, despite the fact that more and more are set to face inheritance tax on their estates, many are not prepared.

More than 40 per cent of people don't have a will in place, with many saying they have not had time to draft one, or believing it is too early in their life.

Beyond a lack of knowledge, some 40 per cent said they view inheritance planning as the 'last great family taboo'.

Gaita added: 'It can be quite a difficult topic - many people are naturally focused on building their wealth, so the idea of giving some of it away or changing how it's managed can feel uncomfortable.

'When I speak to clients about how their money could help the next generation - from their children, even to their great grandchildren's future - the conversation shifts. 

'They start to think not just about what they've built, but about the legacy they want to leave behind.'

Almost half were aware that a failure to plan for later life care was a common financial mistake but 40 per cent reported that they haven't done so regardless.

More than a third, 34 per cent, said they rarely or never discuss their finances with their family.

Leigh Dunkley, regional manager, at Schroders Personal Wealth said: 'Intergenerational planning is crucial for ensuring that wealth and financial peace of mind are effectively passed down through generations. 

'It helps families prepare for the future, avoid potential conflicts, and make informed decisions that could benefit everyone involved.'

One of the reasons that many avoid proper inheritance tax planning is that they worry over talking about their finances with loved ones, fearing awkward conversations and potential conflict.

But by discussing their plans and wishes, they can lay out what their wills say, what they intend to do and talk about how to reduce a future tax bill, whether through spending more and enjoying themselves now, making lifetime gifts, or other financial planning.

'Discussing finances can feel uncomfortable, but it's only by addressing money matters openly that we can overcome this embarrassment.

'By normalising conversations about finances, we can foster a more informed and supportive environment where family members feel empowered to share their financial goals and challenges without fear or discomfort.'

Ben Waterhouse, chief client officer at Schroders Personal Wealth, said: 'By addressing these topics early, families can avoid potential conflicts and make informed decisions that benefit everyone involved. 

'We encourage everyone to start these crucial conversations today to ensure peace of mind and financial security for future generations.'

Inheritance tax - and who pays it

Inheritance tax is levied at 40 per cent on estates above a certain size.

Your estate is the term given to all the things that you own at death. Valuing this involves adding up everything, from your stake in your home, to your savings and investments, your car and your personal belongings.

As an individual, your estate needs to be worth more than £325,000 for your loved ones to have to stump up inheritance tax.

This can be doubled to £650,000, jointly, for married couples or civil partners, who have not already used up any of their individual allowances.

A further crucial allowance, the residence nil rate band, increases the threshold by £175,000 each for those who leave their home to direct descendants. 

This gives a total potential extra boost of £350,000 and creates a potential maximum joint inheritance tax-free total of £1million. 

But the own home allowance starts being removed once an estate reaches £2million, at a rate of £1 for every £2 above the threshold. It vanishes completely by £2.3million.

Currently, unspent pension pots are not included in people's estates for inheritance tax purposes, but Chancellor Rachel Reeves wants to change this from April 2027.