It is said that people who are “healthy, wealthy and well advised” rarely pay inheritance tax (or rather, their estates do not). If they are rich enough to give money away, and healthy enough to live for seven years, gifts will not be liable for inheritance tax (IHT). But there are myriad other ways to avoid paying, including pensions, the new £1m family home allowance and certain qualifying investments — and these were all discussed at FT Money’s latest reader event this week.
“You are all here because you’re worried about IHT, and you know there is probably a way to get around it,” FT Money columnist Merryn Somerset Webb told the audience of 250 readers. “By having a tax that is very easy to avoid if you have enough money, we give our over-70s in particular a phenomenal burden to carry, because they’re constantly concerned that they’re not doing enough to avoid the tax for the benefit of their children.”
Arguing that the IHT rules were far too complicated and in urgent need of reform, she said that back in the 1970s, the IHT allowance was far lower in real terms, yet very few people had to pay.
“Back then, the average house cost around £7,000. So within your IHT allowance, you could have two and a bit houses. Today, in the south, you can probably get up to three-quarters of a house,” she said.
Chairing the event, FT Money editor Claer Barrett pointed out that in the tax year to April 2016, the government raised £4.66bn via IHT — an increase of more than 20 per cent on the previous year. On Wednesday, HMRC published figures for the year to May 2017 showing this had surpassed the £5bn mark.
Soaring house prices mean that many more families will be liable for IHT — but they are also often desperate to pass money down to their children and grandchildren to enable them to buy a property, she added.
However, Ms Somerset Webb said there was a danger that families could give away too much, too soon — and end up being dependent on their children if they lived for longer than expected or had expensive care needs in later life. “Trust me, they won’t thank you for that,” she said. “The best gift you can give your children is your own financial security in later life.”
She proposed abolishing IHT and replacing it with a gift tax — similar to the old capital transfer tax — meaning any gift to anybody would be taxed at the point of transfer. “It should be a tax on the living, with unearned income taxed at the same rate as earned income, ending all the complexity.”
Vanessa Houlder, the FT journalist and tax specialist, talked through some of the more common methods of mitigating the tax. The new family home allowance (officially known as the “residence nil-rate band”) allows couples to pass on a family home worth £1m — but only under certain conditions.
“This idea of a million pound IHT threshold clearly resonates with the electorate. But it is one of the most complicated pieces of tax legislation I’ve ever had the misfortune to delve into,” she said.
“Broadly speaking, as well as having a £325,000 IHT allowance each, by 2020, couples will also get an extra £175,000 allowance each if they have a house that they will pass on to their direct descendants — children, grandchildren or stepchildren. But if the estate is worth more than £2.7m, they won’t be eligible — and if you had previously set up a family trust to avoid IHT, this could complicate matters.”
As well as the “seven-year rule”, individuals can give gifts worth up to £3,000 per year (or £6,000 if they did not use the previous year’s allowance) drop dead the next day, and not pay IHT, Ms Houlder said.
You can also give away gifts of up to £250 to any number of people, and make regular gifts out of your surplus income completely outside of the IHT net, as long as it does not affect your standard of living. This is worth bearing in mind if you are thinking of setting up a regular savings plan such as a Junior Isa, Junior Sipp or stakeholder pension for younger relatives.
You can put £325,000 into a trust IHT-free every seven years — from which you could even take regular income while alive. And if you have a defined contribution pension pot, you can pass this on tax free after your death — something that has helped to drive up the numbers of people “cashing in” final salary or defined benefit schemes.
“If it lasts, then it is the most wonderful way possible of avoiding IHT — but I can’t see that happening,” said Ms Somerset Webb, in response to a reader’s question. “That said, another upside to Brexit is that they probably won’t have time to enact any pensions reforms for years to come.”
The panel also discussed business property relief (BPR) that can be used to avoid paying IHT on a range of assets as long as they have been held for two years before death.
Originally brought in to allow family businesses to be passed down without being sold or punitively taxed, BPR relief also applies to farmland, certain shares listed on Aim and unlisted enterprise investment schemes (EIS).
“There really is quite an industry packaging these investments up,” Ms Houlder noted. But in the desire to avoid tax, is it really worth picking a risky investment? The panel warned that the fees for these (often illiquid) investments were usually very high, and the valuations of companies had been significantly boosted by their tax-friendly status. If the relief is removed or restricted by a later government, the reverse could apply.
David Carroll, head of strategy at the event sponsor Seven Investment Management, said that passing on your wealth to the next generation was not just about tax planning. Financial education was also a vital component.
Clients frequently ask him if he can speak to their adult children — long before they inherit — about managing their money and the importance of regular saving and investing.
“Parents want their children to engage with money so it doesn’t become a scary, or even ambition-destroying force,” he said. “Their motivation is that they want to teach their children how hard it is to accumulate wealth, and not to waste it.”
If you would like to be kept informed about future FT Money events, please email email@example.com and head your message “Reader Events”.
Get alerts on Personal Finance Advice & Comment when a new story is published