Interest rate on paying inheritance tax in instalments has shot up to 3.75%

People who opt to pay inheritance tax in instalments to avoid selling the family home are being walloped by the recent interest rate hikes.

They are now forced to fork out 3.75 per cent – the Bank of England base rate plus 2.5 per cent – if they choose to spread payments to the taxman over up to 10 years.

After four base rate rises this year and potentially more to come, the cost of paying off an inheritance bill this way will become too expensive for some families, according to financial services group NFU Mutual.

Inheritance tax: Families often sell the family home to pay the taxman, but you can opt do this more slowly if you want to hang onto the property – or other assets deemed to take ‘time to sell’ – if you are willing to fork out the interest

‘The ability to pay inheritance tax on property over 10 years allows bereaved families to hold onto the family home that might otherwise need to be sold,’ says Sean McCann, chartered financial planner at NFU.

‘Over recent years families who have opted to pay by instalments have benefited from house price growth that has outstripped the rate of interest charged by HMRC.

‘As the cost of HMRC interest payments rises, many of those same families will find the payments unaffordable.’

How much is inheritance tax and who pays? 

You need to be worth £325,000 if you are single, or £650,000 jointly if you are married or in a civil partnership, for your loved ones to have to stump up death duties.

But there is a further chunky allowance – known as the residence nil rate band – which increases the threshold to a joint £1million if you have a partner, own a property, and intend to leave money to your direct descendants.

Once an estate reaches £2million this own home allowance starts being removed by £1 for every £2 above this threshold. It vanishes completely by £2.3million

If you are worth more than this, your heirs will have to hand over 40 per cent of your assets above those levels to the Government.

>>>10 ways to avoid inheritance tax legally: Read a This is Money guide

McCann adds: ‘Some families will be reluctant to take on what is effectively a variable rate loan from HMRC and will feel forced to sell.’

Headline inflation hit 9.4 in June and the Governor of the Bank of England, Andrew Bailey, has hinted a 0.5 percentage point interest rate rise to 1.75 per cent could be on the way.

This would push HMRC’s interest rate on inheritance tax instalments to 4.25 per cent.

Meanwhile, HMRC has recently seen a spike in inheritance tax receipts, with a 19 per cent rise to £1.8billion between April and June compared with the same period last year – a trend blamed on rising house prices.

McCann says: ‘Inheritance tax normally needs to be paid within six months and executors can’t get probate and release the estate to the family until the bill is paid.

‘They often need to borrow money to pay the bill, which can be expensive, and, in many cases, families feel forced to sell the family home quickly to repay the loan.’

Opting to pay the bill in 10 equal annual instalments therefore allows a family to keep the property if they prefer, he explains.

How to pay IHT in instalments: What are the rules?

Sean McCann of NFU Mutual offers the following guide.

– The first instalment is due within six months of the end of the month in which death occurs

– There is no interest on the first instalment

– The following instalments are due annually on the anniversary of that date

– HMRC charge interest on the outstanding inheritance tax balance at base rate plus 2.5 per cent

– Each annual payment will include interest on the outstanding balance

Sean McCann: Over recent years families who have opted to pay by instalments have benefited from house price growth that has outstripped the rate of interest charged by HMRC

Sean McCann: Over recent years families who have opted to pay by instalments have benefited from house price growth that has outstripped the rate of interest charged by HMRC

– Families can change their mind at any point and pay the full amount of inheritance tax due

– If the property is sold the right to pay by instalments ceases and the full balance becomes due

– This is also the case if a mortgage is taken out on the property or if it is used as security for a loan

– If a house you received as a gift subsequently becomes chargeable for inheritance tax because the person who gave it to you dies within seven years, you may also be able to pay any inheritance tax due by instalments.

Meanwhile, McCann notes that if you are owed money by HMRC, it pays interest of the base rate minus 1 per cent, with a lower limit of 0.5 per cent.

As the base rate is currently 1.25 per cent, this lower limit – known as the ‘minimum floor’ – kicks in, he explains.

So, HMRC pays interest of 0.5 per cent but charges interest of 3.75 per cent at present.

What are the pros and cons of paying off an inheritance tax bill more slowly?

Shaun Moore, tax and financial planning expert at Quilter gives his take below.

You might opt to pay inheritance tax in instalments on items deemed to take ‘time to sell’ simply because you don’t have enough available (liquid) cash to pay the full bill when it’s due and/or because the item is to be retained by a beneficiary so there is no intention or desire to sell.

This can cover a variety of asset types but one of the most common is the family home. HMRC allow you to pay 10 per cent plus the interest each year over 10 years in this example.

Advantages: One of the benefits of paying in instalments, beyond retaining the asset, is that it takes the pressure of paying often hefty bills quickly.

Often executors who lack liquidity within the estate turn to short term loans (often referred to as bridging loans) to fund the inheritance tax liability.

This can come with high rates of interest compared to longer term lending and there needs to be a plan to repay the loan at a future point. By taking the pressure away, assets (which are not to be retained) within the estate can be sold for their full market value.

Disadvantages: Arranging payment in instalments doesn’t come without drawbacks. Interest is still payable to HMRC on the second and all subsequent instalments on the full balance of the outstanding tax as well as on any instalments that are not paid on time.

This means you may end up paying a lot more in tax over a 10-year period than if you had paid the inheritance tax all at once but sometimes this simply isn’t possible.

The interest rate is currently 3.75 per cent which although it may be attractive compared with bridging loans, makes it worth paying off the debt sooner rather than later if possible.

If the asset which allows the inheritance tax to be paid in instalments is sold (for example, house or shares) then the full outstanding balance of the tax must be paid.