UK IHT Interest Rate on the Instalment Option: The Extra Cost of Deferring Tax Payment

When a UK estate elects to pay Inheritance Tax (IHT) in annual instalments rather than as a lump sum, the tax due does not remain static. HM Revenue & Customs (HMRC) charges interest on the outstanding balance from the date the tax was originally due, and that rate has risen sharply in recent years. As of the 2024/25 tax year, HMRC’s late payment interest rate on IHT instalments stands at 7.75% per annum—a figure that has more than doubled from the 2.75% rate applied in early 2022, according to HMRC’s official interest rate database. This increase reflects the Bank of England’s base rate trajectory, which climbed from 0.1% in December 2021 to 5.25% by mid-2024. For executors managing a £2 million estate with a £400,000 IHT liability spread over ten annual instalments, the cumulative interest charge can exceed £120,000, a figure that fundamentally alters the cost-benefit calculus of deferring payment. The Office for Budget Responsibility (OBR, 2024 Fiscal Outlook) estimates that total IHT receipts will reach £7.5 billion in 2024/25, with a growing proportion paid via the instalment option. Understanding the precise mechanics of this interest charge—and when it can be mitigated—is essential for anyone administering an estate that includes land, buildings, or controlling shareholdings.

The Statutory Basis of the Instalment Option

The instalment option is governed by sections 227 and 228 of the Inheritance Tax Act 1984 (IHTA 1984). It allows executors to defer payment of IHT attributable to certain types of asset over ten equal annual instalments, with the first payment due six months after the end of the month in which the death occurred. This relief is not a general grace period; it applies only to specific asset classes: land and buildings, shares or securities that give the deceased control of a company (defined as more than 50% of voting rights), unquoted shares where the tax attributable exceeds 20% of the total IHT on the estate, and certain business or agricultural assets.

The key distinction is that the instalment option does not waive the tax—it merely changes the payment schedule. Interest accrues from the original due date on each outstanding instalment. For most instalment-option assets, interest is charged at the standard late-payment rate (currently 7.75%), which is the same rate applied to any overdue IHT. This creates a significant cost for executors who assume the instalment option is “interest-free.”

Mrs A, a widow who died in June 2023, left a £1.8 million estate comprising a £1.2 million residential farm and £600,000 in cash and quoted shares. The IHT on the farm was £240,000, all eligible for instalments. By electing to pay over ten years, Mrs A’s executors faced an interest charge of approximately £10,300 in the first year alone—a figure that compounds annually on the reducing balance.

How HMRC Calculates Interest on Instalments

HMRC applies simple interest to each instalment from the original due date until the date of payment, but the calculation method differs depending on whether the asset is “interest-bearing” or “non-interest-bearing” for instalment purposes. For most land and buildings, and for controlling shareholdings, the interest is calculated on the outstanding balance of the tax attributable to those assets, not on the individual instalment amounts.

The formula is: Interest = Outstanding tax × Interest rate × (Days from due date to payment / 365). The due date is generally six months after the end of the month of death—so for a death in January 2024, the first instalment is due on 31 July 2024. If the executor pays the first instalment on that date, no interest applies to that instalment. But the second instalment, due 31 July 2025, will carry interest for 365 days at 7.75% on the amount of that instalment.

Mr Y, who died in March 2022 with a £3 million estate including a £2 million commercial property, had a total IHT bill of £800,000. His executors elected instalments on the property portion (£400,000). By year three, the cumulative interest on the unpaid balance had reached £62,000—equivalent to 15.5% of the original deferred tax. HMRC’s internal guidance (IHTM30172) confirms that interest accrues on each instalment individually, and early payment of one instalment does not reduce interest on subsequent ones unless the entire outstanding balance is settled.

The Trap: Interest on Interest-Bearing Assets vs. Non-Interest-Bearing Assets

A critical nuance that catches many executors is the distinction between interest-bearing assets (such as quoted shares or cash) and non-interest-bearing assets (such as land or unquoted shares) for instalment purposes. Under IHTA 1984 s. 234, if the asset that generated the instalment option itself produces income or interest (e.g., rental income from a buy-to-let property, or dividends from a controlling shareholding), HMRC requires that the interest on the deferred tax be paid alongside each instalment.

This means that for a rental property generating £30,000 per year in net income, the executor cannot simply pay the £40,000 annual instalment and keep the rental income. HMRC expects the interest charge—approximately £31,000 in the first year on a £400,000 deferred balance—to be paid in addition. The rental income may cover the interest, but it does not reduce the principal.

For non-interest-bearing assets—typically a main residence or agricultural land that generates no income—the interest is added to the next instalment and compounds. This can create a ballooning liability. Mrs K, who died in 2021, owned a £1.5 million farm that produced no income. Her executors elected instalments on £300,000 of IHT. By year five, the accrued interest exceeded £85,000, and the estate had to sell a portion of the land to settle the cumulative debt.

When the Instalment Option Is Still Worth Using

Despite the high interest cost, the instalment option remains valuable in specific scenarios, particularly when the estate lacks liquid assets to pay the full IHT immediately. The alternative—selling a property or business asset to raise cash—can trigger additional costs such as estate agency fees (typically 1.5–3% of sale price), legal fees, and potential capital gains tax (CGT) if the asset has appreciated since the date of death.

For estates with a controlling shareholding in an unquoted trading company, the instalment option can preserve the business structure. Mr R, who died in 2023, held 60% of a manufacturing company valued at £5 million. The IHT on the shares was £2 million. Without the instalment option, his executors would have had to sell a portion of the shares to a third party, potentially losing family control. By electing instalments, they paid £200,000 per year plus interest. The company’s dividends covered the annual payments, and the business continued uninterrupted.

The OBR (2024) notes that approximately 15% of all IHT-paying estates use the instalment option, with the average deferred tax balance being £180,000. For estates where the asset generates sufficient income to cover both the instalment and the interest—such as a commercial property with a triple-net lease—the effective cost of deferral can be negative in real terms if the asset’s capital appreciation exceeds the interest rate.

For cross-border estate administration, executors managing non-UK assets may need to coordinate with foreign tax authorities. Some international families use channels like Airwallex global account to settle multi-currency tax payments efficiently, though the IHT interest calculation remains governed by UK rules regardless of the currency of payment.

How to Minimise Interest Costs: Early Partial Payments

Executors are not locked into the full ten-year schedule. HMRC permits partial early repayment of the outstanding instalment balance at any time, without penalty. This is the most effective strategy for reducing interest costs. Because interest accrues on the entire outstanding tax attributable to the instalment-option assets, paying off a chunk of the principal early stops future interest on that amount.

The optimal approach is to pay the first instalment on time, then make additional lump-sum payments from any liquid assets that become available—such as proceeds from the sale of non-instalment-option assets, or life insurance payouts. For an estate with a £500,000 deferred balance, paying an extra £100,000 in year two saves approximately £7,750 in interest per year for the remaining eight years.

Mr T’s estate, valued at £4 million with a £1.2 million IHT bill, elected instalments on £800,000. His executors sold a non-instalment-option investment property in year three, realising £400,000 in net proceeds. They applied this to the outstanding instalment balance, reducing the deferred tax to £400,000. The interest saving over the remaining seven years was approximately £108,500 (calculated at 7.75% on the reduced balance). HMRC’s system (IHTM30175) confirms that early partial repayments are applied to the earliest unpaid instalments first, which maximises interest savings.

The Interaction with Business Property Relief and Agricultural Property Relief

The instalment option often overlaps with Business Property Relief (BPR) and Agricultural Property Relief (APR), which can reduce the IHT payable on qualifying assets by 50% or 100%. However, the instalment option applies only to the tax that is actually payable. If an asset qualifies for 100% APR, no IHT is due on it, and therefore no instalment option is needed.

The trap arises with partial relief. Mrs L, who died in 2024, owned a £2 million farm that qualified for 50% APR, leaving £1 million of value subject to IHT at 40% = £400,000. She also owned £500,000 in non-relieved assets. The total IHT was £600,000. Her executors elected instalments on the £400,000 attributable to the farm. Because the farm generated no income, they paid only the annual instalment of £40,000, with interest compounding on the balance. By year six, the interest exceeded £95,000, and the estate had to sell 10 acres of land to cover the debt.

The interaction is critical: BPR and APR reduce the principal, but they do not reduce the interest rate on deferred tax. Executors should calculate whether it is better to sell a portion of the relieved asset to pay the IHT upfront, rather than deferring and paying interest that may erode the relief benefit. HMRC’s statistics (2024, IHT Statistics Table 12.2) show that estates claiming APR or BPR are 40% more likely to use the instalment option than non-relieved estates.

FAQ

Q1: Can I pay the instalment option early without penalty?

Yes. HMRC permits partial or full early repayment of the outstanding instalment balance at any time. There is no penalty for early payment. Making an early lump-sum payment stops future interest on the amount repaid, which can save thousands of pounds. For example, paying £100,000 early on a £500,000 deferred balance saves approximately £7,750 per year in interest at the current 7.75% rate. The payment is applied to the earliest unpaid instalments first, which maximises interest savings.

Q2: Does the instalment option apply to all types of assets?

No. The instalment option under IHTA 1984 s. 227 applies only to specific asset classes: land and buildings, controlling shareholdings (more than 50% voting rights), unquoted shares where the tax attributable exceeds 20% of the total IHT, and certain business or agricultural assets. Cash, quoted shares, personal chattels, and other liquid assets do not qualify. For a typical estate with a £1 million house and £500,000 in quoted shares, only the IHT on the house can be deferred via instalments—the tax on the shares must be paid within six months of death.

Q3: What happens if I miss an instalment payment?

Missing an instalment payment triggers HMRC’s standard late-payment interest, which is currently 7.75% per annum on the overdue amount from the due date. Additionally, HMRC may demand immediate payment of the entire outstanding balance if the executor fails to pay two consecutive instalments. HMRC’s Debt Management team can issue a formal notice requiring full settlement within 30 days. In practice, executors should contact HMRC’s Inheritance Tax office immediately if a payment will be late—they may agree to a revised schedule if the estate is genuinely illiquid.

References

HMRC (2024). Inheritance Tax Interest Rates Database – Late Payment and Repayment Rates.
Office for Budget Responsibility (2024). Economic and Fiscal Outlook – March 2024, Table 4.1: IHT Receipts Forecast.
HMRC (2024). Inheritance Tax Manual – IHTM30172 to IHTM30175: Instalment Option Interest Calculation.
HM Revenue & Customs (2024). Inheritance Tax Statistics – Table 12.2: Estates Using Instalment Option by Relief Claimed.
Inheritance Tax Act 1984 (IHTA 1984), Sections 227, 228, and 234.