Four in five well-off people are convinced they know how inheritance tax works but most are kidding themselves, new research shows.

Out of 3,000 people who earn above the £33,000 average annual salary and have at least £1,000 in cash savings, just a quarter aced a six-question test on the topic.

Misplaced confidence could lead to many families either caught off guard and facing burdensome bills or overprepared for future liabilities, said financial services firm Charles Stanley after carrying out the study.

The number of families paying inheritance tax is bound to rise in coming years due to frozen thresholds, high property prices and pending pension changes.

Inheritance tax is levied at 40 per cent on estates above a certain size. A couple leaving a family home to children and grandchildren can pass on a joint £1million tax free.

The key inheritance tax thresholds are explained below, or check our guide to inheritance tax.

Charles Stanley found 80 per cent of well-off people, weighted to be representative across all regions of the UK, claim they grasp how inheritance works.

Yet when probed further it turned out they were unclear on the rules, and especially on how much inheritance tax would be payable on their own estate.

Some 52 per cent said they knew how much their families would have to hand over to the taxman, but 48 per cent admitted they had no idea.

Meanwhile, some whose total assets are under the main £325,000 threshold for individuals wrongly think they will be liable.

The Charles Stanley research discovered the following knowledge gaps.

- Among those with an estate worth under £100,000, 42 per cent think that inheritance tax will be owed when they die, and estimate the amount at £35,000 on average although it would be zero.

- For those worth between £100,000 and £325,000, so still under the main threshold, 55 per cent think inheritance tax will be payable, and predict it as £48,000 on average.

- Many people with estates that could be liable are also in the dark. 

Among those worth from £325,000 to £750,000, the average estimated to be payable was £56,000. Among those worth £750,000-plus the average estimated was £77,000.

However, thresholds are complicated so the amount could vary significantly in reality. 

Some people's estates could be lifted out of IHT wholly or in part depending on whether they are married and passing a family home to their direct descendants.

But assuming no reliefs at all apply then on an estate worth £750,000, which is £425,000 above the basic individual threshold, a 40 per cent bill of £170,000 could be levied.

'Passing down an estate can be a great tool to building generational wealth, giving loved ones a chance to reap the fruits of your labour,' says Rob Morgan, chief investment analyst at Charles Stanley.

But he warns: 'A lack of understanding or knowledge around the IHT payable could catch them off guard, shouldering a large sum to pay which may result in the unnecessarily swift liquidation of assets or property sales.

'This is why estate planning is a critical aspect of wealth management - allowing you to make the most of your estate and finances, whether this is through gifting or donating in preparation, or even just keeping beneficiaries in the know to avoid any unpleasant surprises down the road in your absence.'

Do YOU understand inheritance tax? Take the test

Here's what Charles Stanley asked people to test their knowledge. Answer TRUE or FALSE to the statements below, then scroll down to find the correct answers and check your score.

1. Inheritance tax is only payable if the value of your home is above £325,000

2. Inheritance tax must be paid when anyone dies

3. If your estate is worth up to £325,000, inheritance tax must be paid on that full value

4. Inheritance tax is charged at 40 per cent if the value of the estate is above the £325,000 tax-free threshold

5. Everyone who received money from the individual who passed away in their lifetime is responsible for paying inheritance tax

6. Only those who received gifts from the deceased individual in the last seven years prior to their death need to pay inheritance tax, provided they gave away more than the £325,000 limit.

Answers

1. False. 2. False. 3. False 4. True* 5. False. 6. True**. 

How did you do?

Scored 0: See the box below and follow the links to our guides

Scored 1-3: You need to brush up on your knowledge

Scored 4-5: Well done

Scored 6: You aced it

Measure how you did against the original 3,000 people tested by Charles Stanley

The percentages who got a correct score for each question was as follows. 1. 30 per cent 2. 45 per cent 3. 42 per cent 4. 55 per cent 5. 44 per cent 6. 38 per cent.

* Some people might have got question four 'wrong' but really be right if they are knowledgeable about inheritance tax. It doesn't account for the residence nil rate band, which increases the threshold by a further £175,000 if you leave a family home to direct descendants, or that it is doubled if you are the surviving spouse in a couple.

** Gov.uk says: 'How Inheritance Tax on a gift is paid - Any Inheritance Tax due on gifts is usually paid by the estate, unless you give away more than £325,000 in gifts in the 7 years before your death. Once you’ve given away more than £325,000, anyone who gets a gift from you in those 7 years will have to pay Inheritance Tax on their gift.' Read our guide on IHT and gifts on what you are allowed to give IHT-free and how to keep a good record.