Inheritance Tax: Surely It Could Be Simpler?
Making the world of Inheritance Tax (IHT) more straightforward is a long overdue requirement.
With the publication of the Office of Tax Simplification (OTS) report on the UK IHT system, however, necessary changes may be just around the corner.
As we covered in our previous article, the current IHT rules in the UK are complicated and full of tax related pitfalls. Without the help of an Independent Financial Adviser, financial planning in this area is nigh on impossible.
All 107 pages of their report, which can be found here, aim to achieve the goal of simplifying this area of advice. The report makes a number of recommendations on the changes that they believe should be implemented; it is now up to Parliament to legislate on the changes they feel necessary.
Unfortunately, this is unlikely to be a priority just yet – there’s still a matter of our European exit to sort out!
For now, if you don’t fancy a lengthy bedtime read on the OTS’ proposal for IHT restructuring, have a glance at the below guide, which provides a summary of their suggestions.
Gifting Allowances and the Nil Rate Band
The current rules on gifting are varied and many people are falling foul of the restrictions in this area. In addition, many of the gifting allowances have not increased in value since their introduction.
The Nil Rate Band, which is the amount each person can pass on after their deaths free from IHT, has been frozen since 2009. The annual gift has stayed at £3,000 since 1981 and the small gifts exemption has remained at £250 since 1980.
Had these individual allowances increased in line with inflation, the amounts we could all gift to our loved ones would be far higher:
Taking the Nil Rate Band alone, if this increase had been applied individuals who are subject to IHT could save just over £39,000 in tax.
As detailed in our previous article, the rules surrounding allowable gifts are complicated, wide ranging and often mis-interpreted.
The OTS has recommended that a single personal gift allowance is introduced, replacing all small and annual gift exemptions. Whilst they have not recommended the level at which this should be set, they believe by abolishing some exemptions and increasing the annual gift allowance there should be little impact on the overall tax received by the Government. It should also go some way towards simplifying the financial planning options clients have in relation to gifts.
Making Gifts out of Regular Income
As discussed in our previous article, it is possible for clients to make gifts out of their regular income. This is allowable providing:
- The gifts made are regular in nature;
- They are made out of surplus income; and
- The gifts do not impact the individual’s standard of living.
Bob’s estate is just below the IHT threshold.
He has an income of £2,000 per month but only spends a maximum of £1,500.
To stop his estate growing and to prevent an IHT problem, Bob could gift £500 to his family each month whilst he is alive.
Bob needs to keep full records of these gifts but, providing these meet all requirements, they will be exempt from IHT on his death.
What has been raised in the OTS report is that the above is very subjective and there is no overall limit applied. What one person classes as ‘surplus’, another may class as essential; what one person deems not have an impact on their lifestyle, another may disagree et cetera.
To address the subjective nature of this gifting exemption, the OTS have suggested this could be limited to a percentage of an individual’s income and to also remove the need for gifts to be ‘regular’.
This would create some parity across individuals facing IHT liabilities and would allow HMRC and executors to ensure this rule is being implemented fairly across the UK.
The Main Residence Nil Rate Band
‘Pass £1,000,000 to your children’ and ‘Government grants families £1,000,000 IHT allowance’ were close to the headlines seen when the Chancellor announced the introduction of the Main Residence Nil Rate Band (MRNRB).
An allowance which permits families to pass on their main residence to ‘direct descendants’, the MRNRB has come up against plenty of opponents since its introduction. With the allowance not being available for those without children, those passing property to nieces or nephews nor for those leaving property to Trust; the number of people that can rely on it is far lower than the media initially suggested.
Its so complicated, there are even reports that some solicitors will choose not to advise clients on this subject.
The OTS have paid particular attention to this as it is a prime area for simplification. Figures reported suggest the scrapping of this allowance altogether would permit the Nil Rate Band to be increased to £376,000 across the UK. However, by taking this action, a further 5,370 estates could fall foul of IHT by 2023/24.
A more suitable solution presented by the OTS, tying in to the first section of this article, is to increase the Nil Rate Band to £500,000 per individual i.e. to truly provide a couple with the ability to pass on £1,000,000 to their families.
However, such a significant increase would lead to far fewer estates paying IHT and hitting the Chancellor with a £7.5 billion reduction in IHT receipts between now and 2024 – I will let you come to your own conclusions as to whether this will be implemented!
Pension Plan and Life Insurance Policies
Unbeknown to many, life insurance policies and older pension plans are often included in individuals’ estate for IHT purposes.
There are simple solutions to avoid this for many clients, such as placing life insurance policies into Trust and ensuring pension plans benefit from the most recent pension legislation. However, few clients take this action, leaving them exposed to large tax bills.
Taking the sort of action discussed above, however, often represents a daunting task for many and therefore there is disparity between the IHT paid by those who sought advice and the larger number of people who do not.
The OTS have therefore recommended the Government consider ensuring death benefit payments from life insurance policies are IHT free and the proceeds from pensions can be accessed by beneficiaries, without being included in their estate value.
However, whilst this recommendation has been made, the legislative changes required for life insurance and pension contacts are significant. It is likely we will see other changes implemented, such as a change to the Nil Rate Band value, before this is considered.
With other focusses and a new Prime Minister, it is unlikely any changes proposed are going to be rushed through Parliament. In the meantime, there are many clients who require advice in this area and the area represents a minefield for those looking to take action themselves.
At Informed Financial Planning we have a wealth of experience in helping individuals plan in this area. Whilst we cannot guarantee clients will not pay IHT on their deaths; by planning early enough, it may be that we can reduce the tax liability significantly to ensure your beneficiaries receive as much of your hard-earned assets as possible.
To book a an initial, no obligation meeting at no cost to you, give us a call on 01482 219 325 or email [email protected].