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A combination of rising house prices and a freeze on tax breaks means the amount of inheritance tax (IHT) payable on inheritances when people die is increasing.
However, to quote the Bachman-Turner Overdrive hit, “They Ain’t Seen Nothin’ Yet”, tax take could soar if Labour carries out its expected fiscal attack on inherited wealth in next month’s Budget.
Rather than a tax that simply nips at the heels of families with modest holdings – a comment made to Money Mail by Paul Barham of tax advisory firm Forvis Mazars – it could start to be phased in in small chunks.
Inheritance tax: Currently, the value of a person’s estate when they die is potentially subject to 40% IHT if it exceeds £325,000.
Anything is possible: removing or limiting allowances that reduce the size of an estate for IHT purposes; increasing the tax rate or reducing tax allowances; and restricting gifts that can be made during life to take money out of the net of IHT. The value of a pension when someone dies could also be subject to IHT.
Yesterday, the left-leaning Resolution Foundation gave us the strongest indication yet that estate taxes are going to rise. Of the £20bn of tax increases it is urging Labour to introduce, inheritance tax features prominently. It says the IHT system “leaves much to be desired” – code for radical increases.
Of course, exactly what Labour will do with IHT will be revealed on 30 October, but people can mitigate some of the pain until then by making use of various gift allocations.
Where we are and what can happen
Currently, the value of a person’s estate when they die is potentially subject to 40 per cent IHT if it exceeds £325,000.
There is also an additional nil-rate band of £175,000 for those leaving their home to a child or grandchild – the full amount available for estates under £2m.
According to Adam Smith, former chief of staff to ex-chancellor Jeremy Hunt, an increase in the IHT rate to 45 per cent would mean an extra £1bn a year. The same increase in revenue would occur if the £325,000 nil tax band was reduced to £275,000.
To put these figures into perspective, total IHT revenues for the first four months of the current financial year were £2.8bn, suggesting that IHT revenues this year will be between £8bn and £9bn.
Experts believe Chancellor Rachel Reeves could cut the main zero-rate band, but this is unlikely.
This is because the £325,000 limit has not changed for 15 years and will remain at this level until 2028 under plans set out by Mr Hunt.
This deep freeze in the threshold means that inflation has eroded the protection it offers, doing the Government’s job of trapping more wealth in IHT.
Jason Hollands, tax expert at wealth manager Evelyn Partners, says that if this tax-free band had risen in line with inflation, it would now be around £500,000.
Funding appropriation: An increase in the IHT rate to 45% would generate an extra £1bn a year. The same revenue increase would occur if the £325,000 nil tax band was reduced to £275,000.
But he believes Ms Reeves could reduce the additional nil-rate band for “residence” from £175,000 to the main band of £325,000, cutting in the process the combined total from, say, £500,000 to £400,000.
Mr Hollands also believes the Chancellor could tier the tax rate, increasing it for high-value properties.
Sarah Coles, head of personal finance at wealth manager Hargreaves Lansdown, says Ms Reeves could also stop the exemption that allows a spouse (in a married couple) to
or civil partnership) to leave everything to their partner free of IHT. The effect of this is to potentially double the nil-rate bands for the main home and residence to £1 million.
“Any change will be unsettling,” says Coles, “but Labour will argue that IHT is only payable on 4 per cent of properties and there is scope to widen the net.”
There are other unpleasant things about IHT that Mrs Reeves could throw in our faces. For example, she could bring pensions into the IHT net.
Currently, if you die before age 75 with a defined contribution pension plan, it is not considered part of your estate.
This means that beneficiaries can receive the income free of IHT. The Resolution Foundation says it “makes no sense” to exempt pension funds from IHT, which would allow them to be used as “bequest vehicles”.
Labour is also likely to reform or end exemptions that allow families and farmers to pass on their businesses across generations without having to pay large IHT bills along the way.
While the Resolution Foundation says the economic case for maintaining business relief and farm relief is “not strong”, others disagree.
Cuts: Labour is likely to reform or end reliefs that allow families and farmers to pass on their businesses across generations without having to pay large IHT bills along the way.
Neil Davy, chief executive of trade association Family Business UK, told Money Mail that around 85,000 family businesses are passed on to the next generation every year.
He said that removing aid to businesses would force some of them to close at the “expense of their livelihoods.” He added: “Changing or removing aid is contrary to justice and common sense.”
Commenting on farm relief, Sean McCann, a certified financial planner at insurer NFU Mutual, said its removal would be “devastating for traditional UK family farms”.
This would result, he warned, in land and buildings being sold on the farmer’s death to pay the IHT bill, with the next generation “inheriting smaller, less efficient farms”.
Mitigating the Damage of the Death Tax
What is not included in the Resolution Foundation’s thoughts on IHT is reform of the rules governing gifts of money by grandparents or parents during their lifetime.
These rules currently allow numerous gifts to be made which reduce the value of the donor’s wealth which is ultimately used to assess whether IHT is payable when they die.
In 2019, the now-defunct Tax Simplification Office published proposals for an overhaul of the donation rules. It said the patchwork of deductions should be replaced by a single exemption. But no action was taken on this.
Nicholas Nesbitt, a partner at Forvis Mazars, believes Labour could “tighten the rules on cash donations, perhaps by taxing gifts above a certain amount or introducing a lifetime limit on the amount people can give”.
With the Budget looming, he says his firm is discussing with clients who want to give gifts when is the best time to do so – or, in other words, sooner rather than later.
Changes to donation rules announced in the Budget are unlikely to come into effect until the start of the new financial year.
But if IHT could become a potential problem in the future, it makes sense to quickly use the various deductions.
Research published yesterday by investment manager Rathbones among “high net worth individuals” showed that 29 per cent have already made financial gifts to loved ones, and some plan to continue making such gifts.
Olly Cheng, director of financial planning at Rathbones, said making plans to pass on wealth was an “essential part of responsible financial and personal management”.
Mr Hollands, of Evelyn, agrees: “For those who are comfortable knowing they have sufficient assets to enjoy their retirement – and do not hate their families – making donations to support their children or grandchildren will be a far more acceptable option than leaving money to the Chancellor.”
Currently, you can make a cash gift to a loved one free of IHT, as long as you live for another seven years – the Chancellor could reduce this seven-year period in the Budget.
IHT-exempt gifts of shares and property can also be made, but Mr Hollands says donors could be subject to capital gains tax (CGT) – such gifts are treated for CGT purposes as if the donor had sold the asset.
You can also use the ‘annual gift’ exemption of up to £3,000 to give money to one or more people (for example, children and grandchildren).
If you didn’t use last year’s allowance, you could also use this one. In this way, a couple could potentially transfer £12,000 worth of gifts and, in doing so, take them out of the IHT target band.
Other permitted gifts that take money out of IHT territory include ‘small’ gifts of up to £250 (per recipient), wedding or civil ceremony gifts (£5000 to a child, £2500 to a grandchild or great-grandchild and £1000 to any other person).
Regular gifts can also be given, but they should not compromise your lifestyle.
These taxes are usually handled by grandparents, but professional advice should be sought. The IHT rules can easily catch people off guard and leave beneficiaries facing an unexpected tax bill.
jeff.prestridge@dailymail.co.uk
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