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‘Complex and not very effective’ IHT under fire

Former coalition pensions minister Steve Webb is among a number of influential figures who have called for the ‘tax on death’ to be replaced by a lifetime receipts tax on gifts

‘Complex and not very effective’ IHT under fire

Since its introduction, inheritance tax (IHT) has undergone continued reform that has led to the measure becoming more and more complex. Sometimes referred to as a tax on death, there have been increasing calls for its disposal.

During a speech at the Liberal Democrats’ annual conference, party leader Vince Cable noted that, if elected, the party would replace IHT with a levy on large financial gifts. This proposal has been well received, with think-tanks and policy spokespeople agreeing IHT is no longer fit for purpose.

According to recent Intergenerational Commission research from the Resolution Foundation, inheritances have doubled over the past two decades, passing £100 billion in 2015/16. With this forecast to double again over the next 20 years as wealth is passed through families, the complexities surrounding IHT are more likely to become an issue.

Figures from HM Revenue & Customs also revealed that IHT receipts totalled a record £5.2 billion in 2017/18, increasing by 8% year on year.

Receipts tax

Although sometimes classed as a voluntary tax – it can be avoided with planning – IHT is often a burden for those unaware of its restrictions and/or unable to obtain financial advice.

‘IHT is clearly a complex and not very effective tax,’ says Royal London director of policy Steve Webb. ‘Those with financial advice can often find ways of avoiding or minimising IHT, so it often ends up being a tax on those without the benefit of financial planning.’

If IHT is disposed of, it could be replaced with a tax on gifting. The Resolution Foundation has suggested a ‘lifetime receipts tax’. This would give individuals a lifetime tax-free allowance, with further thresholds above this amount for lower and higher rates of tax.

Resolution Foundation senior economic analyst Adam Corlett says: ‘Rather than tweak our failed inheritance tax system, it should be scrapped altogether and replaced with a new lifetime receipts tax. This new system would be fairer to families, harder to avoid and would ensure our tax system keeps up with 21st century Britain.’

The measure could raise an estimated £5 billion more than IHT in tax receipts by 2020/21.

Under review

Another option, says Webb, is taxing recipients of inheritances rather than the estate. Webb thinks this could in fact result in less tax being paid overall.

Under the freedoms introduced in 2015, pension wealth is better protected than many other assets under the current IHT rules. Money held in pensions does not form part of an estate for IHT purposes.

Webb says: ‘The introduction of the freedoms and in particular the favourable IHT treatment of pension balances on death has made holding pension wealth rather than housing wealth more attractive.’

However, with the ever-changing nature of tax policies, savers should not depend on the current system going unchanged, Webb adds. ‘It is highly likely a future government might change this favourable IHT treatment of pension balances, so people should not plan on the assumption this concession will always be there.’

While it is unclear whether the government will make immediate changes to IHT in the upcoming Autumn Budget, it is, however, working to understand some of the issues. The Office for Tax Simplification’s (OTS) inheritance tax review call for evidence and survey is due to be published this autumn. It will detail responses to its inquiry on the processes involved with IHT and individuals’ experience of the tax.

But the fact remains IHT raises money the government needs. ‘As IHT raises around £5 billion a year, it is hard to see the government simply abolishing it,’ says Webb. ‘While the OTS is undertaking a review, I suspect that will cover the details rather than the principle of the tax.’

Why we need to rethink pension death benefits.

IHT explained


The demand for inheritance tax (IHT) planning is likely to continue to rise as more UK families come in contact with this complex area of taxation.

The Office of Tax Simplification is carrying out a review of the tax at the request of Chancellor Philip Hammond. Some rules, such as business relief, may change.

So what are the rules as they stand now?

£3,000 annual gift exemption. Gifts of up to £3,000 can be made each year tax-free. This amount has been unchanged since 1981. If the full amount is not used it can be carried over to the following year.

Most gifts to individuals (not trusts or businesses) are potentially exempt transfers. However, if the person gifting dies within seven years of giving the gift they may be liable to IHT. This tax amount reduces depending on how long ago the gift was made.

The residence nil-rate band is increasing to £175,000 by 2020/21. It was introduced in April 2017. This is applied to the value of a property first before the nil rate band, which is £325,000. So in 2020/21 the total IHT allowance for individuals’ estates will be £500,000. For couples it is double this, £1 million. After this a 40% tax applies. People must leave their estate to direct descendants.

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