The issues, political, economic and social, surrounding Inheritance Tax, by estate planning expert Robert Cartmell
I, Robert Cartmell, having worked in ‘estate planning’ areas of work for over 25 years, have always known the existence of Inheritance Tax as a factor that affects Estate Planning for individuals.
Some people say IHT is unfair and we should abolish Inheritance Tax completely.
Others say that changes should be made.
What is likely to happen in future?
Inheritance Tax – who pays it and when?
IHT is payable on assets owned by an individual at their date of death or on the value of gifts made within 7 years prior to death. It can also apply to some lifetime gifts made into Trust at the point of transfer.
There are certain tax-free allowances where the estate passes
- to a spouse; or
- to UK Registered Charities; or
- subject to Business or Agricultural property relief (for business or farming assets); or
- where the estate is otherwise under £325,000 in value (inclusive of lifetime gifts made in the previous 7 years).
IHT is paid by the beneficiaries out of the estate that passes to them. That can be complicated if the asset with value is the family home. There are allowances for tax to be paid on such assets over 10 yearly instalments. But it can cause significant strain on the family.
So, it is not everyone whose estate is subject to IHT.
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. This is the main ‘nil rate band’.
Some people are fine with the 40% rate and the thresholds given that there is an extra allowance available called the Residence Nil-Rate Band (RNRB) available.
The RNRB increases the threshold to a joint £1million if you have a partner, own a property, and intend to leave sufficient of your estate directly to your descendants.
Once an estate reaches £2million the RNRB starts being removed by £1 for every £2 above this threshold. It vanishes completely by £2.7million (where two spouse entitlements are claimed).
If you are worth more than this, your beneficiaries will have to hand over 40% of your assets above those levels to HMRC.
Only around 5% of estates are liable for inheritance tax, but bear in mind that the thresholds are currently frozen until 2028. So that number of cases will rise.
Why is inheritance tax so unpopular?
Inheritance tax is generally unpopular even though the overwhelming majority of people aren’t rich enough for it to be levied on their estate’s beneficiaries.
IHT punishes – at a sensitive time for family
The dislike of IHT may stem initially from the fact it is seen as a punishment following the death of a loved one. A death tax.
IHT is a tax on property ownership
IHT is also often viewed as a tax on property and of the natural desire to pass wealth down the generations and retaining the ‘family home’. There is the fact that the British have a culture of affinity with homeownership.
40%!!
The 40% is also sounds drastically high.
Tax on the Rich
It is viewed as a tax on the rich. And to most people, they assume that should not mean them.
Regional Diversity
Despite some recent shifts (due to working from home and other factors) we still have considerable divergence of property values. It is a much bigger issue in London and the south east. That, no doubt, does not elicit much sympathy with people living elsewhere. People inheriting property in the hottest house price spots, often due to work or family ties rather than by choice, are generally on the hook for the biggest sums.
The need to help our children
Inheritance for children from parents has now become both an expectancy and a necessary requirement/supplement as those children may be approaching retirement themselves.
So, given its unpopularity, what would be the best way to ease the burden of inheritance tax – perhaps raise the threshold, or cut the rate levied, or just abolish it altogether.
How would YOU reform inheritance tax?
If you were able to act as Chancellor, what would you do about inheritance tax?
Some of the options are:
1. Raising the IHT threshold
The IHT thresholds have been frozen since 2009 and are planned to be frozen at least until 2028.
Would hiking the threshold play to the belief that only the rich should pay the tax?
Exempting more estates by raising the threshold would give relief to middle-class families, who were apparently not the original intended target of inheritance tax.
The RNRB is complex and not very well understood. If the RNRB was scrapped and the Nil-Rate Band of £325,000 was increased, that would simplify the process for many.
2. Cut the 40% rate
This might sound an obvious starting place but we have had this rate for so long (decades- and even since Death duties prior to the 1970s before Inheritance Tax) this would be an unexpected move to make.
Reducing the rate would lead to a reduction in tax revenue. It is predicted not to please many people as the principle of Inheritance Tax would still remain.
An alternative would be to bring in a tiered rate (such as now exists with Stamp Duty Land Tax). That might be say 40% for high value estates and a lower rate for smaller valued estates. That might be a possibility as the position is that an estate of £40m would currently pay the same tax rate (40%) as an estate worth £3m.
So, that might be possible but it needs careful thought and probably would lead to complexity in terms of forms, calculations, fees incurred.
As it stands, with good estate planning, lifetime gifts can be made (using trusts or straight gifts) and with sensible financial planning also, the effects of IHT can be limited by many. But it requires action and planning. Some will take that step, others will not. The situation arises where a degree of inequality exists between people taking advice and planning and those that do not. That will be inevitable when taxes have a degree of complexity to them, as is the case currently.
3. Abolish IHT outright?
No doubt a popular course of action for people whose estate would pay significant IHT under the current rules. But it would no doubt please others who view the existing law as unfair or flawed.
The obvious problem is lost tax revenue, which would need to come from elsewhere, but there could be other unforeseen ramifications.
Some people have already taken steps to arrange their assets into IHT protection vehicles (such as Business Relief assets, like AIM listed shares). If IHT was removed, the value of such investments might fall.
By abolishing IHT, it would be lauded by those who like the idea of someone building up their wealth throughout their lifetime, paid tax on income and should be able to rest easy that their assets will pass in their entirety to their loved ones – and the generations to come.
Thus extending this, abolishing IHT could boost wealth creation (as people see the incentive of doing so). This can lead to a more prosperous economy.
Efficiency savings: IHT is also a heavy administrative burden – for not only estates (in terms of tax but also as to professional fees) but also to HMRC processing the huge quantities of IHT tax returns where little (or even where no tax) is payable.
But surely this is not the time to abolish it altogether. The current economic outlook for the UK is not strong – this could compound this reality.
IHT is also a tool used by Government for evening out the distribution of wealth. This is an important role. IHT affects the wealthiest households, with the top 10% of estates typically accounting for majority of the overall IHT paid to Government.
4. Change lifetime gifting rules
The Government’s independent tax panels suggested some reform to the standard ‘lifetime gifts’ rules but nothing has come of this. but no action was taken.
CoCould families be afforded a larger scope than the current £3,000 annual gift allowance (for IHT exemption). That does seem a woefully inadequate amount, and it has not been uplifted with inflation for a long time (since the early 1980s). It could be £10,000 rather than £3,000?
The ‘7 year rule’ also appears very antiquated. How can HMRC expect executors to report correctly on lifetime transfers made over such a long time prior to death? Also, there is so much false expectancy that the 7 year tapering applies after year 3 whereas in the vast majority of gifts made, tapering does not apply.
Maybe reforming this area will be seen as the solution for Government at this time. Considering the current economic backdrop, it would be wise to change this and it is clearly justifiable and probably without too much of an impact for Government whilst giving a boost to the public.
5. Should we change nothing?
Surely the country needs to have a tax levy on wealthy estates in these times of financial ‘crisis’?
Inheritance tax is apparently relatively lucrative for HMRC.
Statistically, more and more estates are getting caught simply because of property wealth.
Maybe it is a necessity to have this.
It goes into Government coffers and which are badly needed to pay for other important projects (maybe not HS2).
Is it needed to help keep public finances afloat? Getting rid of IHT entirely would lead to a loss of £7billion a year in revenue.
Overall
So, how do you feel about this?
Do you think it is a fair tax on the wealthiest that should be let alone, or even made tougher? Or should there be some real and radical reform?
For our part, we hope that Government does review Inheritance Tax and look to improve some obvious areas. A step-by-step improvement could start with:
- Reducing the 7 year lifetime gift non-exemption period to (say) 5 years.
- Amend the tapering rules for lifetime gifts. Make the tapering count as against the value of the gift not against the amount of tax attributed to the gift.
- Increase the £3,000 annual exemption allowance in line with inflation (£10,000 would be reasonable);
- Scrap the Residence Nil-Rate Band as it is complex and confusing to administer; and instead
- Increase the basic £325,000 threshold to £500,000 per person.