The main emphasis of the report published by the Institute for Fiscal Studies (the “IFS”) is that the wealth of the younger generations will for the first time be far more dependent on inherited wealth than on their own ability to earn wealth.
The report contains some quite alarming statistics (or perhaps not when the impact of rising property prices is taken into account).
- The average non-pension wealth of households of over 80’s rose by a staggering 43.75% over the ten years from 2002-03 to 2012-13.
- The number of households of over 80’s who expect to leave an inheritance of £150,000 has risen from 24% to 44%.
- The top half of households of over 80’s hold 90% of the wealth of those households and within that group the top 10% hold 40% of the wealth.
- More than 87% of the richest fifth of people born in the 1970s have received or expect to receive an inheritance, compared to 58% of the poorest fifth.
What this means in terms of inequality on inheritances, is that a ‘lucky half’ of younger households are likely to benefit from the vast majority of the inherited wealth of the older generation. That said, there is very strong evidence that inheritances have become far more important for both high and low income households.
The major source of the wealth boom of the last ten years is undoubtedly rising property prices and an increase in the rate of property ownership amongst the elderly.
This, combined with the fall in defined benefit pension schemes, lower rates of home ownership for the young and a decline in incomes in real terms all mean that for the younger generations their own future wealth will be much more dependent on what they inherit.
It might be thought that in light of this clear trend in increased inequality, that inheritance tax would be a means of redressing the balance. Whilst inheritance tax revenues are clearly on the increase, currently standing at around £4.7b a year (based on 2015-16 figures), and having risen by 22% from 2014-15, IHT is only payable by around 20,000 estates (or 3% of deaths per annum). It is expected that the 2016-17 figures will show an increase both in terms of tax revenue and the number of estates paying IHT, but that may well be short-lived as the new transferable residential nil rate band which comes into effect from 6th April 2017 will undoubtedly reduce the number of estates subject to tax.
The new relief is designed for families owning residential property to make it easier to pass that property down the generations free of tax. The relief is being phased in, starting at £100,000 per person (or £200,000 for a couple), for claims arising on deaths in 2017-18, rising to £175,000 or £350,000 for a couple) for deaths and claims arising in 2020-21 onwards. Critically the relief only applies to property left to children or grandchildren, including step children, and it does not apply to property left to say nieces and nephews or non-relatives. This can only add to the inequalities highlighted by the IFS and must surely make that report even harder reading for Ministers, particularly bearing in mind that Theresa May vowed to create a “a truly meritocratic Britain” – where everyone would have a “fair chance in life”.
The rules surrounding the residential nil rate band are complex and quite restrictive in some circumstances. The relief starts to fall away where the estate is worth in excess of £2million on death and is no longer available where the estate exceeds £2.2m for 2016-17 rising to £2.35m by 2021-22 when the full relief is in place. The relief is transferable from one spouse to another in order for double relief to be claimed on the second death. In that situation the upper limits for the relief to apply rise to £2.4m for 2016-17 and £2.7m for 2021-22.
No account is taken in the valuation of the estate for assets which are exempt from IHT due to business or agricultural property reliefs. The threshold is based on the gross estate pre-reliefs, but interestingly failed potentially exempt transfers are not brought back into account. Although death bed gifts may well be ineffective in that they will be taken into account in determining the chargeable estate, they are effective in determining whether or not the residential nil rate band will be available. As in any other situation where a relief is gradually tapered out once a threshold has been exceeded, taxpayers who qualify for the relief but whose estates fall in the relevant band in which the relief is tapered, will see a 60% IHT charge in that band. That is a headline Ministers would not wish to see. However, with careful planning around lifetime gifts and use of Will trusts on the first death it may well be possible to avoid being caught by that 60% trap.
The IFS report has prompted some conflicting opinions, as highlighted by Paul Johnson, Director of the IFS in his article in the Times. He rightly points out that on the one hand increased inheritances will be celebrated in some quarters but will be a source of great anxiety in others.
It has long been recognised that inheritance tax is often not an issue for the very wealthy as they can afford to pass on wealth tax free by gifting more than 7 years prior to death, and by making full use of business and agricultural reliefs. For the less well-off who are subject to IHT primarily because of rising property values, they will welcome the new residential nil rate band which will remove many from the IHT net altogether. Their argument has long been that they have earned their wealth and have paid tax on those earnings so why should they also suffer a tax charge on death? The reality is perhaps less clear as much of the wealth that is currently subject to IHT is derived from the rapid growth we have seen in property prices in this country which by and large is tied up in family homes. As there is generally no capital gains tax on private residences it is difficult to justify that argument in the current climate at that growth in value has not been subject to any form of taxation. Whether the IFS report will lead to a re-think on inheritance tax policy to address the whole issue of inequality remains to be seen as it is inevitably a political hot potato.
For the time being, IHT remains a topic close to the hearts of many clients and they will want to continue to try and mitigate the liability where possible. The new residential nil rate band provides a simple solution for some, but for others who are either outside the relief altogether or who may have the relief restricted now is the time to consider their options further. We offer a full IHT consultancy service including the preparation of Wills so are well placed to advise clients on minimising their IHT liability.
For further information and help with inheritance tax issues, please contact the TaxDesk on 0845 4900 509 and ask for Carol Wells.