Skip to content
Home Link Logo

Self’s assessment: Inheritance tax

Heather Self explains why it’s not time to abolish inheritance tax, as some suggest, but rather reform it

Inheritance tax (IHT) has been with us in one form or another since the introduction of estate duty in 1894. From 1974, there was a tax on lifetime gifts, but this was abolished by Nigel Lawson in his 1986 Budget, when he renamed capital transfer tax as IHT. It is now, as the name suggests, primarily a tax on inheritances, but lifetime gifts within seven years of death are also charged, as are gifts into trust. It raises some £7bn a year – significantly less than the ‘big 3’ of income tax, national insurance, and VAT, but still a meaningful amount.

Despite the fact that only about 4% of estates pay IHT, it is widely regarded as an unpopular tax. This may be because many people wrongly expect to pay it, but it is also likely to be because people are keen to leave an inheritance to their children and aspire to leave them enough to bring themselves within the IHT regime. Although the personal exemption has been frozen at £325,000 for some years (it would be over £400,000 if it had been index-linked), any unused allowance can now be allocated to a spouse or civil partner. Furthermore, the exemption is increased to £500,000 if the estate includes a house which is left to children or grandchildren (but not other relatives), so that in practice a couple can generally leave up to £1m without an IHT bill. Nevertheless, with the continued freezing of allowance thresholds and the apparently inexorable rise of London house prices, more estates will be dragged into the net in future years.

It is therefore perhaps not surprising that the Conservative party floated the idea of abolishing IHT recently. It is also not surprising that most tax experts think this is a very bad idea.

Part of the issue may be that people simply do not understand the basics. During a long and boring car journey on a recent Sunday afternoon, I set out a simple overview on Twitter which received more than 50,000 impressions – indicating both a high level of interest, and a failure by politicians to explain the basics before they suggest major change.

Paul Johnson of the IFS, in his regular column in The Times on Monday 17 July, was in blistering form. As he pointed out, with an air of keen frustration, it would show that on the government’s priorities, ‘continuing to protect the assets of a relatively well-heeled minority continues to come high up the list and concern for social mobility a long way down’.

Dan Neidle, of Tax Policy Associates, highlighted that most IHT planning is done by those who are seriously wealthy: there is a significant fall off in the effective rate for estates over £9m. This is partly because, once your wealth is well over £1m, you can probably afford to give away significant sums and still retain enough for a comfortable lifestyle. You can also benefit from investing in assets which qualify for the (generous) reliefs for business and agricultural property.

Some IHT savings are also made by using trusts, but less than most people would think. As Dan said in the reply to one of the comments: ‘Trusts mostly aren’t useful tax planning for UK domiciled individuals these days’. It is really not helpful that newspapers continue to write articles about how to save IHT, focusing on trusts (such as ‘How a trust can help cut inheritance tax’, The Times, 16 July 2023). And advice to put a family home into trust during an individual’s lifetime is particularly dangerous, in my view; not only will the CGT exemption for a principal private residence be lost, it could well not save any IHT at all if it falls foul of the gifts with reservation rules. But worst of all, family relationships can and do break down, and finding that you no longer have the right to live in your own home could be far worse than leaving your children a relatively modest tax bill.

There is currently one IHT exemption which is rather odd, and benefits those with undrawn personal pension pots. If an individual dies before age 75, their pension pot is not subject to tax at all; if they die after that age, there is still no IHT, but the recipient is charged to income tax on any withdrawals. However, a recent consultation on the abolition of the pension lifetime allowance contained (deep in the details) a proposal that income tax should apply to all recipients, whatever the age of death. Steve Webb, a former Pensions minister, commented that this proposal had come ‘through the back door’ (‘Inherited pensions at risk as Treasury plans a shake-up’, The Times, 21 July 2023).

So, if abolishing IHT is a bad idea, what could be done to improve it? The general view is that broadening the base and reducing the rate would make the tax both simpler and fairer. For example, the Resolution Foundation points out that it is mainly very wealthy estates that benefit from agricultural and business reliefs. As Dan Neidle says, these reliefs could be capped or restricted to apply to a more limited range of assets (for example, family businesses which are being passed on to the next generation), and this would permit a significant reduction in the rate – perhaps to 20% or 25%.

In short, please don’t abolish IHT, but make it simpler and fairer. If only there was an independent body that could look at the options – such as an Office for Tax Simplification…

Would you like to know more?

If you have any questions or would like to discuss your specific circumstances, please get in touch with your usual Blick Rothenberg contact or Heather Self using the form below.

This article was originally published in the Tax Journal and is reproduced with kind permission.

Contact Heather

Heather Self Great Queen Street
Heather Self
View Heather's profile