Is inheritance tax too complicated?
Chancellor Philip Hammond has called for a review of inheritance tax to ensure that it is ‘fit for purpose,’ amid concerns that the current complicated system is hindering an individual’s ability to put together a long term plan.
Inheritance Tax applies to a fairly small proportion of UK residents, but the amounts being collected are rising each year with official figures showing that the £4.8bn collected in 2016-17 is expected to rise to £5.3bn by the end of 2018 and increase again to total of more than £6bn by 2021-22.
The chancellor has indicated a number of aspects for review including the various reliefs and exemptions at the heart of our current system.
The standard nil-rate band, currently £325,000 is the value of each individual’s estate which is not subject to Inheritance Tax (IHT) with amounts above this being taxed at 40 per cent. Due to an increase in residential property prices meaning many more individuals were having to pay IHT purely as a result of the value of their home, a residence nil-rate band (RNRB) was introduced in 2017 allowing an additional £100,000 to be set against the main residence’s value, and this is expected to rise to £175,000 by 2020/21. This is available where the value of the estate is below £2,000,000 and is gradually reduced above this level on a £1 of allowance for every £2 of assets
Both the standard and residential nil-rate bands may be transferred between spouses and are exempt from tax, with any outstanding nil-rate bands passing to the surviving spouse on death. Significantly, it is transferred as a variable percentage rather than a fixed figure, with the percentage being the value of the nil-rate band when then surviving spouse pass away.
Gifts. The treatment of different types of lifetime gifts will also be looked at. Currently a gift of £3,000 may be exempt from tax and unused allowances can be carried over from the previous tax year to make £6,000. Repeated gifts of no more than £250 per person are also allowed, as are gifts from annual income not required to fund routine living costs.
You then have the seven year rule where gifts in excess of the £325,000 allowance may be made without incurring inheritance tax, providing it occurs in excess of seven years before death. This is known as a potentially exempt transfer. Sizeable gifts made between three to seven years before death are then taxed on a ‘taper relief’ which works as a sliding scale.
Pensions are another area to be wary of and ensure you are not caught out. Although IHT does not apply to pensions as they are not classed as part of a person’s taxable estate, should an individual transfer their pension while in ill health and then pass away in under two years of doing so, the funds may then be liable to IHT.
Other options to consider may include investments that benefit from Business Relief such as AIM portfolios, where funds are easily reached but are counted as outside an individual’s estate after two years. And ISA’s may be now be transferred to spouses more flexibly to retain their general income and capital gains tax free status.
So what now? This complicated system does not always make it easy to plan ahead and many do not think about IHT planning until they are older and options may be more limited at this point. It is worth taking advice on a regular basis to ensure that any potential future IHT liability is being managed as much as possible.
With potentially significant changes to the lifetime giving element of the IHT regime being considered, some allowances may come to be reduced in the future and existing planning options removed to make the system easier to understand and not all persons may benefit. It is therefore also important that a full review of any changes and how they will impact on an individual’s IHT planning is undertaken as such changes occur , to ensure that a taxpayer does not unwittingly become worse off.