How to navigate the death duty labyrinth
Nothing is certain but death, taxes and death taxes. Sam Meadows looks at ways to protect your estate from HMRC
Dying Britons are becoming an increasingly important cash cow for the taxman. Official data released last week revealed that the amount paid in inheritance tax hit a record high in the last tax year, breaking through £5bn for the first time, as more estates were hit by death duties.
The combination of soaring house prices over the past two decades and an inheritance tax threshold that has remained static for the best part of 10 years has meant that more people than ever before are liable to pay.
While some may think death duties are a tax only on the very wealthy, experts warn that the middle classes are being dragged into the net, and may not realise that they need advice until it’s too late.
According to the latest statistics, more than 5pc of estates were liable for inheritance tax in 2017-18, resulting in a total take of £5.2 bn. Compare this with 2010-11, when less than 3pc of estates paid a total of £2.7bn, and it becomes clear that our dearly departed are becoming more important to government finances.
Andy Butcher, a financial adviser at London firm Raymond James, said: “The middle earners who are being squeezed by everything else are the ones who will be hit here. A lot of people don’t realise they will fall into the bracket just because they’re in a house they bought 20 years ago.”
There are a number of ongoing reviews, most notably by the Office of Tax Simplification, but experts aren’t holding their breath for any major changes. After all, nothing is certain except death and taxes, and death taxes.
How inheritance tax works
The normal threshold for paying tax on the assets you pass to your descendants is £325,000. Any money or other assets above this amount will be taxed, normally at 40pc.
Married couples or civil partners can pass any amount of assets to each other tax-free when one of them dies, and the other can then use their deceased spouse’s allowance. So a wife who outlives her husband could pass on £650,000 to her children, tax-free, when she dies.
However, the introduction in 2017 of an additional allowance relating to the family home, known as the “residence nil-rate band” means that, by 2020, a married couple will be able to leave £1m tax-free to their children.
The picture becomes even murkier with gifting allowances, which allow people to avoid paying tax on transfers made before their death. There are also reduced rates for those giving a chunk of their estate to charity.
This all combines to create a bewildering minefield, with those in their twilight years struggling to work out how much of their estate will make it to their descendants, or the best way to structure their affairs. Some may be confused over whether they will be taxed on their estate at all.
Mr Butcher said the unpredictable cost of retirement, and the potential for having to dig deep for later-life care, made it increasingly difficult to engage in inheritance planning. “You can do all the cash-flow planning you like but it’s becoming harder to get certainty over future costs,” he said.
Despite the labyrinth of legislation, it’s still worth having a go. Here are some scenarios to help you to plan for your future.
I want to pass on my … buy-to-let portfolio
All but the smallest property empires will be liable for inheritance tax. The residence nil-rate band only applies to family homes; buy-to-lets are counted as part of the usual threshold. This means only £325,000 worth of property can be passed on free of tax – and that is without taking other savings and assets into account.
If you leave it until your death, then inheritance tax will be payable on the whole portfolio that falls above the threshold, meaning your children will be forced to find the money elsewhere or sell some of the properties.
The easiest way to avoid paying is through gifting, according to Julia Rosenbloom of tax adviser Smith & Williamson, but you will need to make the transfer at least seven years before you die. If you don’t survive for that long, the amount payable is scaled down for each year you live.
There may be other considerations beyond death duties. If the properties have risen in value since the date of purchase, then capital gains tax could be payable, while portfolios with outstanding mortgages could be liable for stamp duty if gifted.
… Spanish holiday home
If you have a dream home in the sun that you want to pass to your children, then many of the same considerations apply when it comes to gifting, stamp duty and capital gains tax. However, there could also be overseas tax liabilities that you will need to consider.
For example, in Spain, there are various regional differences on the amount of inheritance tax a nonresident will pay on Spanish assets. Ms Rosenbloom said it was important, therefore, for those in this scenario to seek advice.
‘People don’t realise they fall into this group as they bought a house 20 years ago’
… family business
Family businesses can benefit from the same gifting rules outlined above, but many will be completely exempt from death duty even if passed on in a will.
According to Ms Rosenbloom, business property relief means that the majority of family-owned small businesses, or shares in similar companies, are eligible for 100pc relief from inheritance tax. You can get the full relief on a business, or shares in an unlisted company, while a 50pc relief is available for some shares as well as machinery, land or buildings used for business purposes.
There is no limit on the value of the businesses that are eligible for the relief, but some are excluded, including those that mainly deal in securities, stocks or shares, and non-profits. The business must also be trading and capital gains tax could still apply.