Almost half of all taxable estates will lose some or all of their inheritance tax allowance within five years as they pass a crucial £2 million threshold.

In 2021-22, some 3,153 estates were valued above £2 million, according to the latest available figures from HM Revenue & Customs, 11 per cent of estates that were liable for inheritance tax (IHT).

By 2027-28, this is set to increase to 5,613, or 20 per cent of taxable estates, according to analysis carried out for Money by the wealth manager Quilter.

It looked at the number of estates worth between £1 million (the maximum a couple can leave tax-free) and £2 million (the point where you start to lose this allowance), and added in the median pension wealth for those aged 55-63, which is £107,300, according to the Office for National Statistics. It then assumed inflation of 2.5 per cent a year, to determine how many estates would start to tip over the threshold.

Quilter estimates that in 2029-30, some 12,383 estates will be above £2 million — equivalent to 44.5 per cent of those liable for IHT.

Why the £2 million point matters

The £2 million threshold is an important one to be aware of when it comes to estate planning, and breaching it could result in a bigger tax bill for your family.

Everyone has a £325,000 IHT allowance, which they can pass on tax-free to whomever they choose. Any value above this amount is typically taxed at 40 per cent. This threshold has been frozen since 2009 and is set to remain so until at least 2030.

Since 2017, there has been an extra £175,000 allowance for those leaving their main home to a direct descendant, such as a child or grandchild, known as the residence nil-rate band.

Couples who are married or in a civil partnership can combine their allowances to pass on an estate of up to £1 million together. Estates of any value can pass to a surviving spouse IHT-free, with them then being able to pass on the full £1 million when they die.

However, once the value of an estate exceeds £2 million the additional £175,000 allowance starts to be removed. For every £2 above the threshold, an estate loses £1 of the nil-rate band until at £2.35 million it is gone entirely for one person, or £2.7 million for a couple, where there are two nil-rate bands.

As IHT thresholds remain frozen but the value of assets such as property and pensions rises, more estates are being caught in the net.

A record £8.2 billion in IHT was paid in 2024-25, according to HMRC, up from £7.5 billion the previous year, and from £3.8 billion in 2014-15.

The situation is likely to worsen from 2027 when pensions are set to become liable for IHT. This is because after property, a pension is likely to be a person’s second biggest asset. The Office for Budget Responsibility estimates that IHT receipts could reach £11.7 billion in 2027-28 and £14.3 billion by 2029-30.

Rachael Griffin from Quilter said: “Many more estates are set to become liable for IHT as pension wealth is brought into scope. The frozen residence nil-rate band will compound the problem for families with estates nudging over £2 million, where that valuable allowance starts to taper away. For those with significant property and pension wealth, it could mean a much bigger tax bill than expected.”

HMRC figures show how breaching the threshold increases the effective rate of IHT you pay. Estates worth between £300,000 and £400,000 paid an average of 4 per cent IHT in 2021-22, the most recent data, it said. That rises to 13 per cent for estates worth between £1 million and £1.5 million, and to 19 per cent for those worth between £1.5 million and £2 million. Estates worth between £2 million and £7.5 million paid an average inheritance tax rate of 24 per cent.

Property isn’t the only issue

Rising property prices are already dragging more estates into paying IHT, but contrary to what many think, it is unlikely to be the undoing of all your estate planning.

The average UK house price is £271,415, according to the Land Registry, up 6.4 per cent over the past year.

Across England and Wales, about 0.5 per cent of property sales in 2024 and 2025 were above £2 million, according to the estate agency Hamptons, rising to 2.8 per cent of sales in London.

That is up considerably from 2015, when 0.33 per cent of all sales were above £2 million, and 2.1 per cent of those in London.

Assuming annual property price growth of 2.5 per cent, some 0.6 per cent of sales would breach the £2 million threshold within five years, and 3.6 per cent of those in London, Hamptons estimated.

Aneisha Beveridge from Hamptons said: “High property prices in London mean this is where inheritances are most likely to exceed the £2 million threshold. In general, however, as the total value of an estate increases, property tends to make up a smaller proportion of it.”

Government figures show that for estates worth more than £2 million, property made up about 25 per cent of the total value, compared with about 60 per cent of the value of estates worth between £200,000 and £400,000.

The big pension problem

It is pensions that will be the real sticking point for many people as their wealth increases.

At present savings within a defined contribution pension are exempt from IHT. But in the October budget, the chancellor Rachel Reeves announced that this would change from April 2027. The government is now consulting on the new rules.

Should the plans go ahead, the Treasury expects pensions to bring in £640 million in their first year of being liable for inheritance tax, rising to £1.46 billion in 2029-30.

Someone aged 40 with £100,000 in pension savings could have a pot of £812,000 by age 75, without making any further contributions, assuming annual investment growth of 6 per cent after fees.

If they contributed a further £200 a month until age 60, and then stopped making contributions, the pot could be worth more than £1 million by age 75.

Long-term investment growth is one of the main appeals of saving into a pension but, coupled with the rising values of property and other assets, could have the unwanted side-effect of bringing an estate over the £2 million threshold.

• Get ready for the big pension tax grab

Quilter found that one in five of its clients aged 55 and over could be subject to IHT from April 2027 — a six-fold increase from present levels.

Chris Etherington from the accountancy group RSM said: “The pension IHT changes have prompted lots of discussions with clients, and the complexity of the rules makes it really difficult for people to understand how they will be impacted without taking advice.

“The effective tax rate you pay can be really punitive if a pension pot pulls an estate over the £2 million threshold, and many people want to take action now.

“One challenge is that we only have draft proposals, so there is a risk of rushing to take decisions now when there may still be changes made to the rules before April 2027.”

How to avoid the threshold

Careful planning can help to avoid a larger-than-expected IHT bill. Making use of annual gift allowances is an obvious place to start.

Everyone can give away up to £3,000 a year without it being liable to IHT, and as many gifts of up to £250 as they like, provided that the beneficiary has not also benefited from another gift allowance.

It is possible to give much larger sums IHT-free as long as you live for seven years after making the gift. If you die between three and seven years after making the gift it will remain part of your estate but be taxed on a sliding scale if it qualifies for IHT.

Giving out of surplus income is a little-used rule that can be very effective. Individuals can give away excess cash tax-free, as long as doing so does not affect their standard of living. The money must come from regular income such as a pension or salary, rather than from savings, and you will need to keep records to prove a regular pattern of giving.

More people are using life insurance as a tool to cover any IHT bill they leave behind. A whole of life insurance policy written in trust can pay out a lump sum when you die. This can be particularly useful for those whose wealth is tied up in property or business assets, which may not be immediately accessible to their beneficiaries.

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Don’t forget to spend money too. Many pensioners worry they will run out of cash or won’t have enough to fund care costs, but it is important not to hoard unnecessarily at the expense of enjoying life.

“It is surprisingly easy to drift into the IHT net, particularly when investment growth pushes the value of your estate higher over time. Early and proactive planning is important to avoid sleepwalking into a tax bill that could otherwise have been reduced or avoided altogether,” Griffin said.