With the snowdrops and crocuses in full bloom, the daffodils starting to show and the evenings slowly getting lighter, these are all increasing hints that Spring is almost here, although of course we are not there yet and the old saying about March – “in like a lion, out like a lamb” is worth remembering as we may be in for another cold snap.
As we shake off Winter, we go into what I always feel is a very positive time of year and despite all the issues we are bombarded with on a daily basis in the news, I feel it is a time for optimism.
It is too early to judge whether the new agreements reached between the UK and EU regarding the Northern Ireland Protocol will succeed, but the markets seemed to respond in a positive way and the value of GBP also strengthened briefly. Whilst 2022 was an extremely challenging year in markets to say the least, most markets have shown positivity over the last 6 months, although we have yet to regain the values at the end of 2021 in most cases.
As always, there are opposing views as to whether we are simply witnessing a “Bear Market Rally” or the beginnings of a new “Bull Market Run”; the majority view seems to be that over the next few years we are likely to see a return to sustained growth and that perhaps in the short term, Europe and Emerging Markets will be the areas that shine.
As ever, there are no certainties when it comes to the markets and the sentiment that drives them but as we approach the end of the tax year in the UK, and a Budget statement later this month, we can be certain of one thing - tax will be in the spotlight once more. The political debate rages on about whether higher taxes or lower tax rates and greater consumer spending lead to a stronger economy, but there is a consensus that no one likes to pay more in tax than they need to and so I thought I would take a look at one particular tax which was in the headlines recently.
In 1986, Roy Jenkins, Labour politician, famously said that “Inheritance Tax, is broadly speaking a voluntary levy paid by those who distrust their Heirs more than they dislike the Inland Revenue”
If you look today at the HMRC Internal Manual (and I am not suggesting this is a top 10 best seller, must read to add to your list!) It’s opening paragraph states “Inheritance Tax (IHT) is the successor to Capital Transfer Tax (CTT), which was an integrated lifetime transfer and estates tax. Under CTT, all lifetime transfers were charged to tax when they were made. Under IHT, certain types of lifetime transfer remain taxable when made. Most are only taxable if the transferor dies within seven years of making the transfer.”
Why then I ask myself, do we see current reports quoting that HMRC receipts from IHT from April 2022 – January 2023 were £5.9 billion – £0.9 billion higher than the same period last year. Could Roy Jenkins have been right I wonder – surely not! This was quite a contribution to the total tax haul which HMRC have confirmed was £660 billion for that same period, an increase of £65.1 billion over the previous year. Mind blowing numbers!
Why though, if IHT is a voluntary levy, has it increased so much to these staggering numbers? The answer of course is more complex than the question, but I will try to explain some key factors.
IHT was first introduced in the UK in March 1986 and at that time, the threshold (Nil Rate Band) before IHT would be due was £71,000. This increased each year until it reached £325,000 in 2009 and since that time, it has remained frozen at that level. The Office for National Statistics quote the average nominal house price in the UK as £38,251 in 1986, compared to £149,709 in 2009 and £294,844 in June last year.
If you do the sums, in 1986, the average house price was just 54% of the IHT threshold but now it is nearer 91%. That, combined with the increase in second property ownership is one of the key factors for the increase in the total amount. Not forgetting, these are average house prices and certain areas of the country have seen much higher numbers; the London average for example, is nearer double the national average.
Whilst there have been some minor changes since inception, that improved allowances with the introduction of the Residence Nil Rate Band for example, which adds a further £175,000 per individual, this only applies in certain circumstances. Most other allowances have remained static with other changes like the “Pre-Owned Assets” and “Gifts With Reservation” rulers, all restricting the ability make lifetime gifts without losing control of the assets concerned.
You may start to think that IHT planning is not possible and that it is an inevitable tax after all, but that is not the case. It is worth mentioning here that in the UK, the IHT burden does not fall on the individual during their lifetime, but it is their Estate that is assessed on their death and for this reason, some people take the view that the net value of their Estate after payment of IHT is enough for their beneficiaries to receive. However, many people are alarmed at the levels of IHT that will be payable, and with planning, there are steps that can be taken to help reduce or avoid IHT, which I will touch on shortly.
This differs with some other countries, where it is the financial standing and closeness of relationship of the beneficiary to the deceased, that determines the level of tax to be paid. In that regard, the UK system is much simpler to assess.
Another reason why the IHT tax take has grown, is due to people who have moved overseas, thinking that UK IHT no longer applies to them – sadly, that is not necessarily the case. It is not a question of where the individual is tax resident, but rather where they are domiciled. Changing tax residency is relatively straightforward and is automatic, based on several factors, such as where you spend most of your time, but changing domicile is not easy to do, nor is it automatic. Worldwide assets for UK domiciled individuals are assessable for UK IHT, regardless of where that person is tax resident when they die and can be a nasty shock to the beneficiaries when HMRC hold out their hand for a payment that was unexpected!
As you might expect me to say, with some fairly straightforward planning, much can be done to improve the situation whilst still maintaining control over assets to an acceptable degree.
Maximising annual exemptions, small gift allowances, wedding gifts and regular payments (which have no actual limit) are all simple options that many people do not use. None of these trigger the seven year rule.
Something else to consider; if you have a pension fund and you have savings, many people will say they prefer to use the pension for income in retirement and preserve the savings for the next generation. From an IHT planning perspective, that is the exact opposite from the ideal solution. Not only will the pension income in all probability be taxable during the individual’s lifetime, any savings they leave will all form part of the Estate for IHT purposes, with any amounts above the threshold being taxed at 40%. A double whammy!
Most pensions operate under a Trust and except for some occupational and final salary/defined benefit schemes, any residual fund value not spent during the lifetime, can pass to nominated beneficiaries, outside the Estate for IHT purposes, as the assets belong to the Trust and not the individual.
This is probably starting to sound either complex or just plain boring, but if you have any concerns about your own family situation, this is an area where we would be able to guide you and provide the advice needed to achieve your longer-term goals.
Of course, there is one other perfect solution and that is to spend all the money during your lifetime, but that may have some practical issues to consider!
As always, stay safe!
Best wishes from all at ABC