Is inheritance tax fair? Allowances, thresholds and reducing liabilities

31 July 2019

It’s one of the most disliked taxes but there are plenty of ways you can reduce your liability

The taxman has been taking death duties in one form or another since 1694. In its earliest form, inheritance tax (IHT) was known as probate duty, a tax on personal property passed on in wills.

The modern IHT emerged in 1894, when the government of the time brought in estate duty to clear a £4 million government debt. Since then, death duties have proven to be a valuable income stream for the government.
Back in 1993, IHT revenues rose above £1 billion for the first time. Since then, soaring property prices, combined with a stagnant inheritance tax threshold, have meant the government has made more and more money from this much maligned tax. In fact, in 2018 inheritance tax receipts exceeded £5 billion.

Frozen thresholds

Inheritance tax is a duty on the assets you pass on after you die. Everyone has a £325,000 nil-rate band. Assets up to that amount can be passed on tax-free, but anything above that is taxed at 40%.
The inheritance tax threshold has been frozen at £325,000 since 2009. Since then, revenue from the tax has risen by an average of 10% a year. In 2015/16 alone, 24,500 estates were caught in the net, paying an average of £179,000.
Tax is rarely popular, but inheritance tax has long proved to be a particularly hated duty.
“Most people accept that tax is a fact of life, and that, while there might be ways to minimise it, the more you earn, the more you owe,” says Carl Drummond, a wealth planner at Sanlam. “But when it comes to inheritance tax, many clients feel a sense of injustice. After all, they’ve paid taxes their whole life, and diligently saved so as not to be a burden on the state. Why then does the taxman have to take another 40% of their estate when they die?”
Inheritance tax is also seen as unfair because the government is consistently increasing its revenue, while the thresholds for inheritance tax have been frozen for a decade.
The nil-rate band has sat at £325,000 since 2009. If it had been increased in line with inflation, it would now be £437,000. Worse still, the £3,000 gift exemption hasn’t been increased since 1981. Again, if it had moved with inflation, we would now be able to give away over £11,500 a year without incurring inheritance tax.
The actual rate of inheritance tax, 40%, hasn’t changed since 1988. But over that time the revenue received has rocketed, thanks to the allowances not keeping pace with rapid rise in house prices and inflation.
While all of this may be annoying, far more people worry about inheritance tax than ever actually pay it. In the 2015/16 tax year, only 4.2% of deaths resulted in an inheritance tax bill.
“With careful planning, there are ways to minimise your IHT liability,” says Drummond. The first thing is to understand the rules.

Tax-free allowances

By 2020/21, you may be able to pass down up to £1 million free from inheritance tax by utilising two nil-rate bands. The first is the inheritance tax allowance. Up to £325,000 of your total estate can be passed on free from inheritance tax. Married couples can pass this allowance to their surviving spouse. This means when the second spouse dies, they can pass down up to £650,000 without any inheritance tax being owed.
On top of this, there is now the residence nil-rate band. This allows you to minimise the tax bill on your main residence when you pass it down to children or grandchildren. At present you can pass down up to £150,000 (£300,000 for couples) of property without attracting inheritance tax as long as it is your main home. This allowance is increasing steadily each tax year until it hits £175,000 in 2020/21.
Just be aware, though, that the residence nil-rate band tapers off if your estate is worth more than £2 million. For every £2 over £2 million that your estate is worth, the residence nil-rate band reduces by £1.
Using these two allowances will allow individuals to pass on £500,000 tax-free in 2020/21, or married couples £1 million.
Before you start worrying about a future inheritance tax bill and giving money away to minimise it, get an idea of what you might be facing. Make a list of all your assets, what they are worth and how they are invested.
Then consider what you are going to need in the future. “Completing a budget on your current expenses is essential,” says Drummond. “In addition to this, you should also complete a budget on other options, which could include additional holidays and completing the goals you want while you still have the option to.”
Also, factor in possible care costs.
Once you know how much you have and how much you are likely to need (and spend) in the future, you will have a much clearer idea of what your estate could be worth when you die.
“If you are lucky enough to have an estate worth more than £1 million then the rest is liable to be taxed at 40%,” says Drummond. But there are ways you can minimise your bill.


Five ways to limit your liability

“No one wants to think about dying, but it’s important to organise your estate to plan for inheritance tax,” says Sanlam’s Carl Drummond. Here are five ways to cut a potential IHT bill.

  • If you want to cut your inheritance tax bill, shrink your estate. “Spend any excess savings you’re confident you won’t need in the future,” says Drummond.

  • You can give away up to £3,000 a year without any tax implications. Give away more than that and the excess will still count as part of your estate if you die within seven years. You can also give away as many small gifts of up to £250 as you like.

  • On top of the gift allowance you can also give away up to £5,000 before a wedding or civil partnership. If the couple aren’t close relations you can give them £1,000, rising to £2,500 for grandchildren or great-grandchildren, and £5,000 if they are your child.

  • When you die, your pension drawdown fund can be handed on to your beneficiaries without forming part of your estate. This means you can pass untouched pensions on without incurring inheritance tax.

  • Placing an asset into a trust means it leaves your estate so won’t count towards your inheritance tax bill, provided you live seven years from when the transfer was made. There are numerous types of trust and which one is right for you will depend on your circumstances and intentions. A financial adviser can help you choose.

To find out how we can help with your inheritance tax planning, speak to your financial adviser

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