FINANCE AND LAW
Giving away 40 per cent of your wealth to the taxman has never been easier!
Charles Bukowski, the late poet, wrote “There are only two things wrong with money: too much or too little.” This is especially true for those in their retirement years. While a pensioner running out of money with years left to live can be tragic, having too much money in one’s golden years also comes with its own headaches.
In a recent survey by Hargreaves Lansdown, inheritance tax (IHT) was voted Britain’s most hated tax. This isn’t all that surprising. With IHT knocking up to 40 per cent off one’s estate upon death, people aren’t too chuffed being taxed a second time on that which they have already earned, accumulated — and been taxed on before.
Although historically this issue has affected only the richest in society, decades of rising property prices have led to more people being ensnared with this tax, with HMRC collecting a sizeable £5.2 billion in IHT in 2020/21. Typically, a couple will have an IHT exemption of £650,000 and up to £1 million in some cases where their own home is included. However, there is a rapidly growing number of Brits now holding assets greatly in excess of these allowances.
Inheritance tax was one of the areas where Chancellor Rishi Sunak applied a so-called stealth tax in the March budget. By freezing the nil-rate band at £325,000 until 2025/26 (a level it has been held at since 2009) this cuts the exempt amount in real terms as inflation and a sustained rise in property prices have continued to increase the value of estates beyond this allowance.
Yet in a recent survey by AKG, 74 per cent of people had not taken any action to reduce their IHT bill. This could be due to a reluctance to confront mortality as well as the discomfort people find from having these discussions with their spouses and beneficiaries. In addition, the knowledge that they may need to cede control of their assets can also lead to people delaying putting plans into place.
Since the initial market crash at the start of the pandemic, the past 20 months have seen estate values rise sharply due to both strong investment returns and a burgeoning property market.
With the majority of UK wealth in the hands of the over-60s, an age bracket that has lamentably been impacted more than others by Covid-related deaths, HMRC saw an increase of £190 million in IHT receipts on the previous year. Hence it is anticipated that in the next few years there will be a continual rise in those seeking advice on how to mitigate the potential effects of inheritance tax on their estate.
Benjamin Franklin famously said: “In this world nothing can be said to be certain, except death and taxes.” With astute estate planning, however, taxation of the dead need not be a certainty.
For starters one may consider the option of making aliyah. As well as the spiritual benefits one may derive from such a relocation, one will also benefit from the fact Israel does not have an inheritance tax. If a person was domiciled outside the UK (a process that can be achieved, in part, by making aliyah), then IHT would apply only to any UK property they own. All their other worldwide assets would be free of IHT, no matter where their children are living.
But what if you don’t want to make aliyah?
Historically, these issues may have been solved by simply gifting assets to the next generation through the course of one’s retirement. However, the phasing out of comfortable defined benefit pension schemes that have been the backbone of retirement income for many decades has meant that today’s retirees are likely to be much more reliant on their other assets to support them in retirement.
For a typical retiring couple, their two biggest assets will be their pensions and their residential property. Most people will use their pension for retirement income and will retain their property until death before passing it on to the next generation. However, this may not be the best way to go about things.
Property is not the most efficient in terms of estate planning. Although you may gift a property to your children to take it out of your taxable estate, it can require you to live for seven years — or potentially up to 14 years — after the date of the gift for it to be exempt from IHT.
One also needs be wary about ‘gifting’ the family home to one’s children and continuing to live in it. This may be considered a ‘gift with reservation’ and the home will remain in the parent’s estate for IHT purposes.
Additionally, if the property is not the main residential home and it has increased in value since purchase there may be a capital gains tax bill to pay even if it is gifted to your heirs for free. Even attempting to sell the properties to your children for less than the market value will be sniffed out by HMRC and the difference will be treated as a gift and taxed accordingly.
Pensions, on the other hand, (depending on the type one has) can be passed on free of IHT upon death allowing one to shelter over £1 million of one’s estate that can be built up over time outside of their IHT liability.
The residential home however, especially if situated in most parts of the south east, will probably cause a large IHT liability. Hence, one planning technique that may be more effective is building up the pension throughout retirement to increase one’s assets that sit outside their taxable estate and drawing on equity from the house to provide income in retirement and hence reducing the size of their taxable estate.
Perhaps a pension should not exclusively be viewed as a retirement fund in the traditional sense but rather as a tax-efficient investment vehicle that provides shelter from inheritance tax!
Those lucky enough to have assets in excess of their pension and residential home may also want to take advice on how the use of various trusts can help them mitigate IHT while keeping control of their assets and even taking an income from them.
Harry Morris is a chartered wealth manager at Raymond James. Golders Green. He is chartered member of the Chartered Institute for Securities and Investments and a member of the Personal Finance Society. He can be contacted on 020 8202 1944 or harry. morris@raymondjames.com
This article is intended for informational purposes only and no action should be taken or refrained from being taken as a consequence, without consulting a suitably qualified and regulated person