Private school fees and inheritance tax are making the headlines again, so that can only mean one thing: the phoney war that precedes a proper General Election campaign has unofficially started. The battle for Middle England’s votes has begun!
I will recuse myself from discussing Labour’s plans to add 20% “value added” tax to private school fees and stick to IHT, the reform of which has been discussed for what feels like decades. I last wrote about this in January 2020 in an article called “Inheritance Tax Faces Radical Overhaul”, when the unhappily title All-parliamentary Group on Inheritance and Intergenerational Fairness (APGG) proposed slashing the rate from 40% to 10%. Now chancellor Jeremy Hunt could be preparing to go further and scrap what’s labelled “Britain’s most hated tax” altogether. Whether this is “fair” on those who’ve just paid it is a moot point, but I’m sure income tax is more disliked, although less readily associated with death. It's also just an idea at this stage and these "promises" tend to be polled and focus grouped to death before they become a reality.
It's certainly feared by the property-owning classes in the south-east of England, where houses tend to be valued at more than the £325,000 “nil rate band” where the flat rate of 40% kicks in. The amount of estates actually subject to IHT is still less than 10%, although that is rising. April to August 2023 data were published recently and they showed a 10% increase in tax receipts to £3.2 billion. Due to “fiscal drag” from frozen allowances, more people are expected to be liable to pay it. These bands are frozen until 2028 so you can see how that will pull more people into the net despite a softening in house prices. “Don’t be caught out by thinking that this won’t affect you. It’s not just the value of your home that you need to consider, it’s your whole ‘net estate’ after liabilities have been considered and reliefs have been applied, which adds up over a lifetime,” says Julia Peake, tax and estate planning specialist at Canada Life.
This conveys the element of unpleasant surprise that comes with an IHT bill. Circumstance plays its part; often people in receipt of a (very prompt) bill from HMRC are dealing with the loss of a parent and trying to sort out the loose ends that come with winding up an estate. The cliff-like nature of the 40% can hit hard too. The rate is probably the easiest part of IHT to understand. It also seems unfair in that the deceased may have paid a fair chunk in tax over their lifetime and this seems like a ruthless money grab from the government. If you think the state spends your money well, then that shouldn’t be a huge problem. But this does seem like free money given out to an indebted government, and it's no consolation that actually paying the tax puts you into an elite wealthy group. At least income tax feels more voluntary while you’re alive, even though most on PAYE will have no choice. So IHT just adds to the general pile of government money to spend.
Those who think of themselves as “just middle class” may be affronted by this bill, especially if – unlike ultra high net worth individuals – your relatives may be “accidental” IHT victims rather than carefully planning to avoid it.
“IHT is starting to impact increasing numbers of relatively modest estates, and as inflation means property and other asset prices tend to rise in the long term, more families - and more of each family’s savings – will be driven over the IHT threshold. So, possibly more welcome would be a hike in the nil-rate band,” says Ian Dyall, Head of Estate Planning at leading UK wealth manager Evelyn Partners.
It's a reflection of the age of my friends but IHT is one of the personal finance topics I’m most asked about. “Am I liable?” is the first question, and people generally take the £325,000 as an absolute line in the sand. But this is a per-person band, so a for a couple that’s doubled to £650,000. To that £650,000 you can add a “residential” nil rate band, a sort of recognition from the government that the IHT thresholds haven’t kept pace with house price inflation. But it comes with a big caveat: that the property has to be passed on to children or grandchildren. In reality, most descendants sell up. And the taxman is wise to people “transferring” the deeds to their expensive property in their declining years.
Experts tend to insist that the earlier this is tackled the better the outcome for everyone; deathbed financial decisions tend to be poor ones and often too late. It’s worth asking an IFA about gifting opportunities, charity and to explain the much mentioned “seven year rule”.
I would urge the reader to look at the official tax tables and seek financial or tax advice rather than rely on media articles. In summary though, the threshold may be higher than you think. That’s the other confusing part of the estate unwinding process, working out what’s included for IHT purposes. With the annual articles about “ISA millionaires” doing the rounds every March and April, IHT could be the tax to spoil the party. ISAs may offer many tax benefits but IHT isn’t one of them. ISA nest eggs can really catch people out who don't think that they form part of the estate.
Some pensions offer IHT exemptions, and that’s one in favour of them as a long-term estate planning tool. But again, don’t just assume that they can be passed on without checking, especially if you have a mixture of defined benefit and defined contribution pensions.
Thinking of investment products, AIM has attracted money in recent years because – in return for supporting British smaller companies – the government gives some IHT exemptions. The same logic applies to Seed Enteprise Investment Schemes, which are popular for those who max out their ISA allowances. Abolishing IHT would be bad news for AIM investment, says Nicholas Hyett, investment manager at Wealth Club. But he says that dedicated IHT-avoiding products make up a small portion of the market. He doesn’t think that IHT will go. “Withdrawing that relief would inevitably hit company valuations and has the potential to create serious market disruption,” he adds.
