Inheritance tax explained by Interactive Investor expert
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Britons have, collectively, paid more inheritance tax in the last year, leading to suggestions there should be a shake up to make estate planning less complicated. The latest figures show the Treasury received £5billion in inheritance tax (IHT) receipts in the financial year up to January 2022, an increase of £700million for the same period a year earlier.
Shaun Moore, tax and financial planning expert at Quilter, explained how more people have been sucked into paying tax on their estate over time.
He said: “Sustained property price growth and asset price inflation has pushed up the value of estates, meaning higher IHT receipts for the Government.
“IHT was once viewed as a tax on wealthier individuals, but the reality is that the average UK property is only £50,288 short of the standard nil-rate band.
“With the nil-rate band and residence nil-rate band frozen until 2026 and house prices still on the up, many more people could face a hefty IHT bill.”
The residence nil rate band was introduced in 2017/18 to account for a high level of house price growth, but Mr Moore said the result has been an “incredibly complex IHT system, which is poorly understood and therefore poorly planned for”.
Mr Moore added that the Office of Tax Simplification (OTS) has said the residence nil-rate band is one of the “most complex” areas of IHT and that some solicitors choose to not even advise clients on it because it is too complicated.
He suggested it may be “time for a rethink” of IHT to make the regime easier to understand.
He explained: “For example, combining the nil rate band and residence nil-rate band would give someone an effective nil rate band of £500,000 in 2022/23.
“If instead the Government left the nil rate band to increase in line with inflation from 2009/10, it would have been worth £428,000 in 2022/23.
“While less than the current combined nil rate band and residence nil rate band, it would be considerably less complex for estates to plan for and it would increase fairness in the system, given the residence nil-rate band is only claimable when the family home is inherited by lineal descendants.
“And with sustained inflation, the nil rate band increased with inflation will eventually converge with the combined nil-rate band and residence nil-rate band.”
He concluded: “Surely some simplification can be found by only having the one nil-rate band, which is reflective of house price growth and inflation?”
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Mr Moore also offered some tips for Britons who are looking to lower their IHT bill:
Making full use of any allowances
He said: “The current IHT system allows up to £175,000 of the family home to be passed on tax-free, which is effectively doubled to £350,000 when combined with the allowance of a spouse or civil partner.
“On top of this, the £325,000 standard nil-rate band is available, meaning it is possible to pass on £1million IHT free as a couple.
“However, it is important to remember the residence nil-rate band only works for those with direct descendants to inherit the family home and is capped at the value of the property being inherited – less any outstanding mortgage.”
Making a gift to family members
Gifting to family could be another way to reduce an IHT bill.
Mr Moore explained: “Gifts to spouses or civil partners are completely free of IHT and each tax year up you can gift up to £3,000 with your annual exemption, so as a couple this could be a combined £6,000 a year.
“In addition, there is no limit on excess income – above normal expenditure – that can be gifted.”
Consider a transfer
More significant gifts classed as Potentially Exempt Transfers (PETs) or Chargeable Lifetime Transfers (CLTs) will take seven years to see the IHT benefit.
Mr Moore said: “As well as reducing the taxable estate value, larger transfers can be particularly useful for estates of more than £2million which are impacted by the residence nil-rate band taper as the gifts can immediately reclaim the extra band.”
Julia Rosenbloom, tax partner at Smith & Williamson, said the latest IHT collections figures represent a “decent uplift for the Treasury”.
She warned: “The Chancellor’s next Budget could bring in changes to personal taxes that may affect the feasibility of families passing wealth to the next generation and, accordingly, the level of IHT payable.
“While we wait for confirmation as to when the next Budget will actually take place, it’s important for families to think carefully about their tax planning and take professional advice to ensure they use their current allowances before any possible changes are introduced.”
Even if no direct changes are made to inheritance tax in the next Budget, Ms Rosenbloom warned many families could still expect to see increased IHT bills in the coming years, due to the current five-year freeze on the nil rate band and residence nil rate band.
She added: “This is bringing more estates into scope on the back of rising property values in particular.
“By planning ahead, there are a number of areas where an IHT bill could be reduced or eliminated. For example, families could consider investing tax-efficiently and making gifts to family members.”
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