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The surge in UK inheritance tax payments to record levels has generated the usual cries of anguish.
Some tax advisers call it “the tax on death”. For others it’s “the tax on grief” or “the tax on bereavement”. The general message is clear — imposing inheritance tax is bad: HM Revenue & Customs is intruding into family lives at a very emotional time.
And they’re taking more each time they call. As official data showed this week, £6.1bn was collected in inheritance tax (IHT) in the year to the end of March. That’s 15 per cent more than in 2020-21 and around 150 per cent more than 20 years ago.
With the government freezing the thresholds at which estates become liable for IHT, these numbers will only get bigger. The Office for Budget Responsibility estimates that families could pay £37bn in inheritance tax over the next five years, 36 per cent more than in 2017-21.
But is this really so awful? IHT generates levels of controversy out of all proportion to its economic importance. It produces less than 1 per cent of total tax revenues. That’s a fraction of income tax on 27 per cent, national insurance on 22 per cent and VAT on 20 per cent. Indeed, IHT is paid on only about 0.5 per cent of deaths in the UK.
So why is there so much debate? Critics say it is fundamentally unfair because tax is levied twice — once when people earn their money and again when they die. But this argument is hardly decisive — VAT is also levied on earned income and is a far bigger tax which hits a much wider range of people, including the poorest.
The real issue is that those who do pay (about 33,000 families in 2020-21) tend to hand over quite a lot — £160,000 on average. They also tend to be reasonably well-off and well-educated: these are people who know how to air their grievances.
To make matters worse, the truly rich can escape a lot of the tax burden, leaving much larger numbers of the averagely wealthy feeling even more aggrieved.
While the headline IHT rate is 40 per cent, the effective rate is often much lower because of exemptions and reliefs. The effective rate is just 10 per cent on fortunes of £10mn or more, compared with 19.5 per cent on those of £8mn-£9mn, says an OECD report citing British research.
Worse, some of the reliefs available at the bottom end, taper away above £2mn: as a result the effective rate on the top £250,000 of a £2.25mn estate is a whopping 60 per cent.
There are three main kinds of tax relief. The most important is lifetime gifts. Anything that you give away seven years or more before your death is IHT-free. Next is the so-called nil-rate band, or the fact that you don’t pay IHT on an estate worth less than £325,000. This goes up to £500,000, if you can pass your main home to your children or grandchildren. Spouses get double, so the combined figure climbs to £1mn
So far so fair, more or less. But the third group of reliefs is one which disproportionately benefits the rich — exemptions from IHT on privately owned companies, woodlands and farms, including land, houses and buildings linked to the business.
The squeeze on the middling well-off has much to do with our obsession with property. If you are very rich, your main home is not usually a big proportion of your total assets. But for those in the middle it is. Older people who cannot or will not sell their family home during their lifetime end up burdening themselves with unnecessary energy and repair bills and lumbering their heirs with tax obligations.
Those with the foresight to move into something smaller in good time can save themselves and their descendants a lot of money. Given that the nil-rate band reliefs total £1mn for a couple, there is plenty of scope to solve the problem, even in London.
From a tax-raising point of view, IHT could be replaced by a 1 percentage point increase in income tax. Given the controversy surrounding the recent 1.25 percentage point jump in national insurance contributions — to finance health and social care — this would be politically explosive.
But the bigger objection to abolishing IHT is what it would say about social and economic inequality, which has been rising in the UK in the past three decades, according to official ONS data.
While inherited wealth is not the main driver — new fortunes have been created at a rate unprecedented since before the first world war — inherited wealth is divisive. Creating your own wealth involves brains and energy as well as luck. Inheritance is a total lottery.
Fortunately, there are ways of making IHT fairer without abolishing it. First, it could be made progressive, so that the effective rate increases with the size of fortune rather than decreasing as now. Most loopholes would have to go, starting with those which allow financiers to get exemptions by posing as lumberjacks and farmers.
Next, as the OECD said in its report last year, governments could tax recipients, as happens in some EU states, instead of the estate, as in the UK and the US. This would reflect the financial position of the recipient, rather than the deceased donor — and allow for better-off heirs to pay more than, for example, their penniless siblings.
Ideally, estate taxes and levies on lifetime gifts would be brought together, so the children of wealthy parents could be taxed on funds received over the years and not, arbitrarily, on the point of death. But this might be a stretch, given the complexity of record-keeping and monitoring that would be required.
For the moment, not much is going to change in the UK. Chancellor Rishi Sunak has declared that IHT allowances will remain frozen for five years until 2025-26. Which means there is unlikely to be any radical overhaul. We have the system that we have, warts and all.
Those who think their heirs might face IHT bills would be well advised to redouble their efforts to minimise the payments. The IHT charge is likely to keep rising, as growing inflation will tend to drive up the value of estates, including property. Alex Davies, chief executive and founder of Wealth Club, says: “The good news is that there are a number of ways that people can legitimately reduce, or even potentially wipe out an estate’s inheritance tax liability.”
Start by writing a will. It never ceases to astonish me that 40 per cent of Britons aged over 55 do not have one. Then, hand out cash — to your family members and to charity — though don’t give away so much that you end up scrounging from your children for your care costs: they may be less generous than you are. Finally, take advice on exemptions and reliefs — they may be controversial but for as long as they exist don’t neglect what HMRC has on offer. It doesn’t often come bearing gifts.
Stefan Wagstyl is editor of FT Money and FT Wealth. Email:stefan.wagstyl@ft.com. Twitter:@stefanwagstyl
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