Inheritance Tax is on the rise, but don’t just blame property
John Humphreys, Inheritance Tax Specialist at WAY Investment Services Ltd
The property market gets a lot of attention and makes a lot of headlines – which is hardly surprising, given that of all the asset classes it is the one that clients will be tangibly aware of every single night they sleep under their own roof. How often have advisers heard clients say “My house is my pension,”, or “My house is my main investment,” leaving that uneasy feeling that clients are too dependent on a single asset class, perhaps not aware enough of the reasons to diversify.
On a similar vein of thinking, property may too often be misidentified as the primary or sole cause of increased Inheritance Tax (IHT) bills. After all, property now has been allocated its own Nil Rate Band – perhaps an appealing headline but somewhat concealing the additional layer of complexity it brought with it. But digging a little deeper into the data on IHT suggests that it not just house price inflation that has been pushing up IHT bills in recent years.
What can we see in the data?
Starting with the headline figures, it has already been widely reported that IHT receipts have been increasing steadily, from £2.7 billion in the 2010-11 tax year to a record £5.2 billion in 2017-18. (1) Of this, £201 million (less than 4% of the total) consisted of transfers to or charges on discretionary trusts. In April 2017, the Residence Nil Rate Band was introduced with the objective to “reduce the burden of IHT for most families by making it easier to pass on the family home to direct descendants without a tax charge.” (2)
A breakdown of assets and liabilities listed on Inheritance Tax returns is available, most recently for the 2015-16 tax year. (3) Looking at the totals for males and females of all ages, Net movable property, including securities, cash, insurance, loans and other assets less other debts and funeral expenses, accounted for a total of £38.2 billion. Net immovable property, including UK residential property, other buildings and land less mortgages, accounted for a total of £41.6 billion – giving a 48%-52% split between the two.
In other words, almost half of inheritance tax was charged on assets that were not property. In the 75 to 84 age group, 50,400 estates included UK residential buildings, with a total value of £10.9 billion. But a larger number of estates - 68,600 - listed cash, with a lower total value of £4.97 billion.
Looking at female deaths in isolation, cash assets more than doubled in each age band, with the over-85s holding a total of £7.22 billion in cash (see table 1). In total £8.15 billion was held in cash by females who had been widowed.
Table 1. Inheritance tax: females
Estates passing on death in 2015-16: estimates of cash assets(‘0000s)
For males, the increase in cash holdings through each age band wasn’t as large in percentage terms but the monetary values are still large, with a total of £9.45 billion held in cash.
Interestingly, the numbers of married (as opposed to widowed) males holding securities and insurance policies dwarf the number of females holding them – 21,600 to 8,770 for securities and 11,800 to 4,450 for insurance policies. Care must always be taken in drawing conclusions about cause from data, but it is interesting to note that in the cohort of people passing away in 2015-16, more married males held securities and insurance policies than married females. A possible explanation is that in the older generations, males were more likely to be the main breadwinner and therefore more likely to be insured and also more likely to have investments. Anecdotally, there are plenty of stories of advisers speaking with recently-widowed elderly female clients who were not aware of the details of their finances, as it was their husband that dealt with them. Outdated perhaps for today’s working generations, but not necessarily for large parts of the generations covered by these statistics.
What are the implications?
So the data suggests that IHT is being paid on property, but also in many cases on cash, securities and insurance policies. What are the implications of knowing this? How a person plans for IHT depends on what assets they hold. Let’s consider property first. If a person’s home is valuable enough to be a likely contributor to an IHT liability and they wish to reduce that liability, they may choose to sell the home and downsize. However, many people wish to stay in their own home and would not want to take such drastic action purely to impact a tax bill. Clients must be reminded that if they wish to give their home away (perhaps to a son or daughter) but continue to live in it, unless they pay a commercial level of rent, there will be no reduction in their IHT liability, as it would be deemed a Gift with Reservation of Benefit.
In contrast, gifting cash, securities or writing life policies in trust could significantly reduce IHT exposure with no practical impacts on daily living. Cash can be gifted directly via a trust, as could securities, - particularly encashing and then gifting ISA holdings where there would be no CGT implications.
It is difficult to envisage a scenario where holding a life policy in trust does not make sense from a tax planning perspective. Admittedly, it takes a (fairly small amount of) time to set up, and there is a (fairly small amount of) paperwork involved, but holding such a policy in trust means that on death the funds can be released immediately without the need to wait for probate, making the administrative work required seem certainly worthwhile. In addition, the proceeds will be outside the estate for Inheritance Tax purposes.
What could the impact be?
Let’s consider an example of a single male or female (see Table 2), with half their estate held in property as shown in column A. In this example, if they take no action their IHT liability would be £130,000. If they followed the IHT planning listed in column B – gifting their securities, c. two-thirds of their cash to trust and writing their insurance policies into trust, but taking no action with their property – their IHT liability could be reduced to £Nil as shown in column C. They could still retain a varying degree of access to the assets in trust, depending on the type of trust chosen, and they would also be able to specify to trustees in a letter of wishes how they would wish the assets to be distributed.
Table 2. Example scenario for inheritance tax planning by asset class
Is there enough time left?
Clearly, the most effective IHT planning takes place by gifting at least seven years before death. A look at the Office of National Statistics life expectancy tables (extract below) shows that, on average, those in the 65-74 year age group should still have plenty of time to plan ahead, with average life expectancies for males and females considerably above the 7 years required to remove a gift from the estate and providing the opportunity to recycle the NRB at least once more (14 years), possibly twice (21 years), depending on the age of the client.
Table 3. UK life expectancy by age (4)
A note on deliberate deprivation of capital
Unforeseen health events can impact the best-laid plans. Advisers should be aware of the rules regarding deliberate deprivation of capital. In the event of a significant deterioration in health, it may be a natural wish to give away assets to family or friends at an increased rate. However, should a person then incur significant social care bills, and should their estate then be reduced so much that additional state support is needed, the local authority may decide to try and retrieve some of the gifts if it deems them to have been given away in order to avoid paying for care fees. Interpretation of the rules varies, and as a result, several cases have ended up in the courts. A family member needing care can be an upsetting situation in any scenario, and a court case would be an unwelcome additional source of stress. As ever, clear record keeping is essential, and clients should consider legal advice. From the local authority’s perspective, they would need to show that avoiding care costs was a significant motivation in order to demonstrate deliberate deprivation, with timing and the immanence of care costs key factors.
Planning ahead is always preferable
Financial planning is never just about property – and nor should it just be property that is blamed when it comes to tax planning. Inheritance Tax can be the single biggest tax bill a person ever generates. Although property can be a significant contributing factor, and in some families the most significant, clients need to be aware that other assets need consideration too. Planning for IHT around a family home can be difficult, whereas holding other assets in trust is not only more straightforward but can also provide a means to avoid lengthy probate delays. Life expectancy figures show that even in later years gifting assets should be considered, but whilst in still good health. As ever, planning ahead is always preferable.