Until relatively recently the tide had been running very much against inheritance tax planning. Successive governments had closed loopholes and negated time-honoured strategies to make what was once dubbed a “voluntary” tax more and more difficult to avoid. Over the past year though those lacking the gift of immortality have been presented with two very valuable estate management tools.
The first I have already discussed at length. Abolishing the so-called pensions “death tax” allows pension funds to be passed from generation to generation, only being taxed at the beneficiary’s marginal income tax rate when cash is withdrawn. Technically a pension fund could always be passed on free of the reviled IHT. The problem was that the so-called death tax (arguably the ultimate exit charge) of 55% more than made up for the IHT exemption.
Last week’s budget though added another tool to the estate planner’s armoury, namely the potential to shelter the family home from IHT. Currently we all “enjoy”, although I’m not quite sure that is the correct verb, an IHT allowance of £325,000. For a couple that sums to £650,000 with a relatively recent innovation being that that allowance can be passed on to the surviving partner upon the first partner’s death. Thus, combined with the fact that trusts tend to be less favourably treated these days, the default option for many married couples is to leave everything to the surviving spouse who will then proceed to give away as much as possible once their own needs have been met (utilising gifting rules and seven year potentially exempt transfers).
What Mr Osborne added last week was a further IHT allowance per person specifically associated with the family home. This will start at £100,000 in 2017 and steadily rise each year until it reaches £175,000 in 2020/21. Thereafter it will rise in line with the Consumer Price Index. When complete it will exempt a £1,000,000 family home entirely from IHT, although everything else will then be taxed at 40%.
The tax planning opportunity comes where people have more modest homes and are relatively cash rich. Granted this doesn’t apply to everyone. However, if you are looking to leave a little something to the kids or grandchildren, it might be worth considering “upsizing” the family home if that is an option.
Let’s put some figures on that. A married couple with a home worth £650,000 could upsize (or at least upvalue) to a pad worth a million. Think luxurious penthouse apartment with a stunning cityscape view! This would potentially save their heirs £140,000 in inheritance tax by sheltering an additional £350,000 in the family home.
Those still looking to downsize will be able to do so by utilising another innovation, the “inheritance tax credit”. This preserves the new allowance for those downsizing so long as the bulk of the estate is left to direct descendants. The hope is that this will encourage retired individuals to free up larger houses for growing families.
It’s only fair to point out that once the family home reaches beyond £2,000,000, the additional allowance is withdrawn at the rate of £1 for every £2 of value.
Additionally you will not be surprised to hear that not only does the Chancellor giveth, but he also taketh away. The cost of all this IHT largesse is that those earning more than £150,000 will see their annual pension contribution allowance stepped down in increments from £40,000 to £10,000.
The upshot though is that families now have two new and very powerful tools to shelter considerable funds for future generations: private pensions and the family home. The caveat, of course, is that the law is so fluid that any beneficial change could easily be reversed with expensive consequences. I suspect though that these two particular changes will be preserved going forward, even if future governments feel the need to temper pension freedoms generally going forward.
Take care out there