Passing on Wealth in an “Unfit” Inheritance Tax System

NOTE: This post is more than 12 months old, and the information contained within may no longer be accurate.

You may be aware that there is currently a Government consultation on inheritance tax simplification, that is seeking the views of the public on how best to reform the inheritance tax system. You may well have seen a plethora of articles in the national press and on television news in recent weeks with headlines like “Third of UK millennials will rent into retirement”, “Millennial housing crisis engulfs Britain”, and “Calls for complete overhaul of unfit inheritance tax system”. Many of these articles are based on a report from the influential political think tank The Resolution Foundation, whose chairman is the former Conservative minister David Willetts. The report, in response to the consultation, criticises the existing inheritance tax system as ‘unfit for modern society”. It recommends abolishing IHT and replacing it with a tax on individuals’ cumulative receipts of gifts from any source. It suggests that taxing individual recipients of inheritances, rather than the estate as a whole, could give parents/and grandparents an incentive to spread their estates more widely. Analysis in the report shows that Millennials, classed as those born between 1981 and 2000, are half as likely to own a home at the age of 30 as baby boomers because of higher prices, low earnings growth and tighter credit rules. In the 1980s it would have taken a typical household in their late 20s around three years to save for an average-sized house deposit. It would now take 19 years. This made me reflect on a growing trend that we are seeing in our clients who are increasingly looking to make lifetime gifts to their children and grandchildren to help them to purchase their own home, rather than leaving an inheritance on death. Gifting with “warm hands” is understandable when currently the average age of receiving an inheritance is 61. Typically the first question we are asked is can I afford to make the gift. The client’s financial plan enables us to highlight the risks and affordability, however there is another aspect of gifting that is often overlooked; and that is the tax implications. Inheritance tax on gifts is quite complex, hence no doubt the Government review to simplify. A gift to an individual is classed as a “Potentially Exempt Transfer”. As the name suggests it is potentially exempt from inheritance tax, provided the donor survives 7 years from the date of the gift. If death occurs within 7 years the potentially exempt gift fails and it becomes a chargeable transfer, and an inheritance charge may become payable. The amount of tax will depend on whether this gift, plus any other gifts in the previous 7 years exceeds the donors Nil Rate Band, currently £325,000. The order of gifts is also a factor with the earliest gift assessed against the nil rate band first. Once the nil rate band is used up the proportion of any gift in excess is taxed at 40%. A common misconception is who pays the tax on a failed gift. It is the recipient of the gift that pays the tax, not the deceased estates. The tax has to be paid within 6 months of the death of the donor, regardless of whether the deceased estate has been settled. Where multiple gits are made to different children/grandchildren, the methodology of the tax calculation could result in the tax falling on one recipient, but not another. This is unlikely to be the donors intended outcome.

With the political focus almost solely on Brexit, and with the Conservatives ill-fated proposals for funding social care in their general election manifesto underlining the political risks involved , I expect that we are unlikely to see any radical reform of inheritance tax anytime soon. With the tax complexities likely to remain with us for some time to come it may be wise to seek professional advice before making that gift.

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