Whilst death duty can be traced back to 1694, modern Inheritance Tax (IHT) was introduced two hundred years later, when the value of land was taxed in order to reduce the Government deficit. These historic forms of taxation only affected the very wealthy, and a very small proportion of estates were liable to IHT.
Increasing wealth, particularly from rising property prices, has now significantly increased the revenue raised by IHT. Reports from H M Revenue & Customs confirmed that IHT receipts topped £6.1bn in the 2020/21 financial year, a 14% increase on the previous year, and the largest rise since 2015. The trend appears to be consistent in the 2022/23 tax year, when reviewing tax receipts from IHT for the 9 months to January 2023.
The most unpopular tax
Whilst we all suffer tax in one form or another during our daily lives, the taxation of assets on death is a highly unpopular measure. According to findings from a survey conducted by Opinium for Hargreaves Lansdown in 2021, IHT beat Income Tax and taxes on spending and investments, when those polled were asked to name the most hated tax in the UK. The findings of the 2,000-person poll revealed that Inheritance Tax (named by one in four people (24 per cent), beat income tax (including income tax and national insurance) into second place, polling 17 per cent.
It is not hard to see why IHT is so unpopular, and at a rate of 40% above the available exemptions, IHT is highly punitive. Government revenue from IHT is only likely to increase, due to the freezing of the Nil Rate Band, which is the amount an individual can leave on death without a charge to IHT applying. This has been set at £325,000 since 2009, and the recent Budget confirmed this level would be frozen until at least April 2028. Of course, over this time, asset values have risen strongly, and the real value of the Nil Rate Band has therefore become lower over time.
In addition to the Nil Rate Band, the Residence Nil Rate Band can also be used to offset IHT, but only for those who leave a property to a direct lineal descendent. This band, which provides qualifying estates with a further allowance of £175,000 towards the value of a property, has also been frozen until April 2028.
Combining the two allowances, for those who are married with children, will raise the potential threshold before IHT becomes payable to £1m. This assumes on the death of the first of a married couple, assets are left to the surviving spouse, and as gifts between married couples are exempt, the Nil Rate Band of the first of a couple to die is not used. This unused allowance can be transferred to the surviving spouse to use on their estate and the same is true for the Residence Nil Rate Band.
With many more families now likely to face the scenario where an estate is liable to IHT, the importance of forward planning is greater than ever. There are several ways you can seek to reduce the impact of IHT, and one of the options is to gift assets during an individual’s lifetime. It is, however, important that careful thought is given to the tax consequences of making a gift, and the impact such a gift can have on the financial security of the donor.
Any gift of cash, or assets, could have IHT consequences. Each individual can make gifts totalling £3,000 per tax year and therefore a married couple could gift £6,000 of capital (plus £3,000 each from the previous tax year if not used) without any IHT concerns. The annual gift exemption is pitifully small, and those with significant IHT concerns are unlikely to resolve them by making gifts that fall inside the annual gift exemption.
Any amount gifted above the annual exemption is treated as a Potentially Exempt Transfer (PET). No IHT is due immediately; however, the person making the gift needs to live seven years from the date the gift is made for the gift to fully escape IHT. This leaves some families facing the prospect of gifts made within seven years of death being clawed back into the value of the estate and assessed for IHT if the donor of the gift dies. A special form of life assurance policy can be taken out to protect the value of the gift, so if the donor of the gift fails to live seven years, the insurance covers the IHT liability on the gift.
The family home
A trap individuals can fall into is to gift the family home away to children but continue to live in the property. This could well fall foul of the Gift with Reservation rules. Such a Gift occurs when an individual gifts an asset, but continues to benefit from it, and if HMRC rule that a Gift has been made with Reservation of benefit, the value of the asset would still be assessed as being owned by the donor of the gift, when IHT is calculated on death.
The importance of planning ahead
IHT is deeply unpopular, and more estates are becoming liable to tax; however, by planning ahead, the impact of this tax can be avoided or even eliminated. Taking the right advice is so important, as traps lie in wait to catch out the unwary. Our experienced holistic financial planners can fully assess the potential IHT liability on your estate and talk you through the options to mitigate the tax burden.
If you would like to discuss the above in more detail please contact one of our experienced advisers here.
Tax treatment varies according to individual circumstances and is subject to change. The Financial Conduct Authority does not regulate tax advice.