I was chatting with one of my best friends a few days ago. We discussed life in the United Kingdom and the recent changes made by the Labour government. While some of her (very) wealthy friends were critical of policies such as VAT on private school fees or the end of the non-dom regime, the new rules on Inheritance Tax (IHT) were without the shadow of a doubt the most difficult ones to accept.

Inheritance Tax in the United Kingdom has always been contentious, balancing government revenues against family wealth preservation. Recent changes by the Labour government have reignited debates and raised concerns about potential unintended consequences, such as the relocation of wealthier individuals abroad.

Let’s examine the rules governing IHT as they stand, the latest reforms, and the knock-on effects that policymakers may have overlooked.

1. The Current Rules: How Inheritance Tax Works Today

Under the existing framework, IHT is levied at 40% on the value of estates above the applicable tax-free allowances:

• The Nil-Rate Band (NRB): This is the baseline allowance of £325,000 per individual. Estates below this threshold pay no IHT.
• Residence Nil-Rate Band (RNRB): Added in 2017, this £175,000 allowance applies when a family home is passed to direct descendants, such as children or grandchildren. Combined, these allowances mean an individual can pass on £500,000 tax-free – or up to £1 million for a couple.
• Spousal Exemptions and Gifting Rules: Transfers between spouses are exempt, while annual tax-free gifts of £3,000 (per person) and smaller gifts of £250 are also allowed.
• Reliefs for Businesses and Farms: Business Property Relief (BPR) and Agricultural Property Relief (APR) reduce the taxable value of qualifying assets, often eliminating IHT liability altogether.

This system appears straightforward, but rising property prices and frozen thresholds mean more estates are being drawn into the IHT net each year.

2. The Labour Government’s Autumn Reforms

In its 2024 Autumn Budget, Labour announced sweeping changes to IHT. These measures, ostensibly aimed at fairness and revenue generation, have stirred considerable debate.

• Extended Threshold Freeze: The NRB and RNRB thresholds will remain frozen until 2030. With inflation and soaring property prices, this freeze effectively increases the IHT burden on middle-income families.
  
• Inclusion of Pension Pots: Beginning in 2027, pension pots passed to beneficiaries will no longer be exempt from IHT. This change particularly targets estates relying on tax-advantaged pension savings.
  
• Capping of Business and Agricultural Reliefs: From April 2026, reforms to Agricultural Property Relief (APR) will introduce significant changes for family farms. The full 100% relief from inheritance tax will be capped at £1 million for individuals, with higher thresholds of £3 million for couples passing assets to direct descendants and £2.65 million for non-direct descendants. Assets exceeding these limits will qualify for 50% relief, resulting in an effective inheritance tax rate of 20% on the surplus, compared to the standard 40%. Although spousal transfers remain exempt, critics warn that the £1 million cap on full relief could force smaller farms to sell land or equipment to cover tax liabilities. This policy, aimed at broadening the tax base and curbing tax avoidance, has raised concerns about its impact on rural livelihoods and multi-generational farming operations.
  
• Abolition of Non-Dom Status: By 2025, long-term UK residents will face IHT on worldwide assets, closing a loophole often exploited by the wealthy to shelter foreign assets.
  

Labour framed these changes as a step toward fiscal responsibility, but they come at a time when many households are already feeling the pinch of rising living costs.

3. The Unintended Consequences of Rising IHT

Economic policies rarely operate in isolation, and Labour’s IHT reforms are no exception. While they might boost government revenues in the short term, they risk creating long-term challenges.

• An Exodus of Wealth: Wealthy individuals and families are increasingly considering relocating to more tax-favorable jurisdictions. The abolition of non-dom status has emerged as a key driver of this trend. Countries such as Portugal and Switzerland, with their lower inheritance taxes, are becoming particularly attractive. Take, for example, that wealthy friend I mentioned earlier leaving the UK due to Labour’s policies—this is a prime example. For the (extremely) wealthy, it’s not necessarily the abolition of non-dom status on the income side that raises alarm. Instead, it’s the taxation of worldwide assets for inheritance purposes that many find unacceptable. And that’s making them leave the United Kingdom.

• A Threat to Agriculture: Farmers argue that capping agricultural relief at £1 million may force families to sell off farms to cover tax bills. This is not merely a financial issue – it disrupts rural communities and could impact the UK’s food security. The government’s announcement has triggered widespread protests from farmers, but Labour defends the changes as necessary to prevent tax avoidance through the purchase of agricultural land. Early December, the Liberal Democrats have urged the government to exempt “working farms” from its new inheritance tax measures. During a debate in the House of Commons, Liberal Democrat rural affairs spokesperson Tim Farron proposed a “working farm qualification exemption” to specifically target those using farms as tax shelters. The debate is far from settled…

• Chilling Effects on Investment: Entrepreneurs have warned that reducing BPR will discourage investment in UK businesses. Fewer reliefs mean higher risks, which could push investors to look abroad, particularly at a time when the UK economy needs to attract capital.

Even as Labour officials tout these reforms as necessary for economic stability, the repercussions – economic, social, and even cultural – could prove far-reaching.

Final Thoughts

Inheritance tax has always been a polarizing subject, and Labour’s recent reforms have only deepened the divide. While the government’s intention to plug fiscal gaps is understandable, the measures could inadvertently weaken key sectors, drive capital out of the UK, and alienate the very taxpayers it seeks to target.

The real challenge for policymakers lies in balancing fiscal responsibility with maintaining a competitive and equitable economic environment. Whether these reforms achieve that remains to be seen. Would love to hear your thoughts.