Inheritance tax: Expert provides tips on avoiding hefty bill
Wealth accumulation may be the last thing on the minds of middle-class families as they endure the cost-of-living crisis, but the UK’s vertiginously steep inheritance tax is an increasingly worrying final blow.
The tax burden is on course to reach a post-war high, according to the latest forecast by the Office for Budget Responsibility (OBR), partly as a result of Chancellor Jeremy Hunt’s freezing of the personal allowance and basic rate thresholds for the next five years.
A similar story is playing out in the realm of inheritance taxes. Everyone benefits from a nil band rate (NRB) of £325,000 – the amount of a person’s estate that can be passed on tax-free – but this threshold will be fixed until 2028 at the level set back in 2009.
The average value of property alone, commonly the most valuable asset in a will, has doubled since then, from around £155,000 to just under £300,000, leaving very little room for anything else to be passed on tax-free.
The Treasury lays claim to 40 percent of the remaining estate beyond that line – one of the harshest rates in the world. The data show the UK’s inheritance tax policies are less generous than those of almost all its Western counterparts.
In 2017, an additional allowance of £100,000 was introduced for those who leave their main home to their direct descendants. This increased by £25,000 a year to reach £175,000 by 2021. This has now also been frozen, albeit only until April 2026.
The application of an immediate 40 percent tax rate makes the UK something of an outlier, with most countries opting for an ascending scale according to the value of the estate. In Germany, for example, after an allowance that can go all the way up to €500,000 (£435,000) depending on the relation, the first €75,000 (£65,000) is taxed at just seven percent.
Considering an estate worth £400,000 (excluding property) the child of the deceased in the UK would get £370,000. In Germany, they would get £392,250.
US citizens are only hit with an estate tax after $12.9m (£10.3m) – an allowance former president Donald Trump doubled back in 2017. An American could pass down a £1million estate including a home tax-free to their next of kin, while a Brit in a similar position would be stuck with a bill of £200,000.
Many countries don’t charge any inheritance tax at all, including states likeminded with the UK in many other arenas such as Australia, Canada, and New Zealand.
For smaller estates, France lives up to its high-tax reputation. Their progressive scale beyond the limited allowances shoots up fast: from five percent on the first €8,000 (£7,000) to 50 percent beyond €1.8million (£1.6million). Even so, for a £1million estate, a French direct descendent would be taxed £272,800 – roughly as much as the £270,000 less than someone in the UK if the estate did not include a house.
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Prime Minister Rishi Sunak will doubtless be tempted to cut the inheritance tax rate or increase the threshold ahead of the general election, but the pushback from Number 11 is likely to be strong.
HMRC is raking in more from death duties than ever before. The £7billion take for the 2022 to 2023 financial year was a staggering £1billion leap from the previous year and is more than double the £3.1billion of a decade ago.
This is primarily because the number of inheritance receipts is going up. As the tide of inflation raises the cash price of everything a person owns, ever more people are finding themselves with estates well beyond the allowance.
In 2020, 23,000 deaths triggered an inheritance tax bill – by 2028 this is expected to grow to 47,000 deaths.
Adding insult to injury is the prevalence of loopholes within the UK system, many of which are only accessible to the uber-rich.
Perhaps the most controversial is the seven-year rule. This allows someone to give gifts of unlimited value without being taxed so long as they survive for seven years.
For a middle-class family whose wealth consists primarily of equity in a house, there is little opportunity to make use of this exemption. For those flush with cash and investments, stretching out their end-of-life handover can lead to millions in tax savings.
You could also invest in Aim, the City’s junior stock market. Young, risky companies they may be, shares only need to be held for two years before being free of the inheritance tax levy. Investing in the stock market, however, is not everyone’s cup of tea.
There are some positives to have emerged from recent tax code changes. In most cases, a pension can be passed on outside of a person’s estate and is not liable to inheritance tax. The abolition of the lifetime allowance from the next financial year means saving as much as possible into a pension is fast becoming a shrewd way to store wealth.
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