Inheritance Tax: prepare for the worst case scenario

Dennis Hall
www.citywire.co.uk 24/01/10

It is an election year and the two main parties are at odds over Tory claims that more than 4 million people in Britain now face an average inheritance tax liability of £60,000.

This follows the government's decision to abandon a planned rise in the individual IHT threshold from £325,000 to £350,000 in the Pre-Budget Report, a decision that means people who might have reasonably expected to be lifted above the threshold will remain subject to this tax.

The Treasury argues that fewer than 3% of estates pay IHT, claiming that Tory figures give an unrealistic assessment of how the tax is actually levied. But looking at the numbers from the National Statistics Office, it’s easy to see how the Tories have reached the conclusion they have, and equally difficult to square that with Labour’s boast that fewer than 3% of estates suffer the tax.

The thing about using percentage figures like 3% is that they sound quite small, but 3% of an estimated 25 million estates is a not so small 750,000. No doubt the actual figure lies somewhere between the two, and whichever it is that’s a lot of potential tax revenue.

However, I’ve heard it said that inheritance tax is a voluntary tax, and in some respects it is. You can of course give enough of your assets away today - and then live at least 7 years in relative poverty.

For the people I advise, inheritance tax is a very real problem, and one that is not easily avoided. It’s is no longer a tax on the super wealthy; it now reaches down into the heart of the middle classes.

There is no doubt that a large number of estates will pay inheritance tax mainly as a result of property price inflation, which has tended to increase in value at a rate greater than the inheritance tax threshold. But there are also an increasing number of people who have saved and invested so that they can support themselves during retirement, only to find the taxman taking a fairly hefty slice of the pie once they pass away.

These are responsible people, having diligently saved and invested in order to be self sufficient in later life. Typically they feel that inheritance tax is an unfair tax that shouldn’t be aimed at them thus they seek advice about how mitigate it. Yet for the majority of people in this situation, whilst they may have a sizeable potential tax bill, they rarely have sufficient free capital to do much about it.

If the Tories did raise the inheritance tax threshold to £1 million (or double for a married couple) this would allow people to stop worrying so much about inheritance tax. More importantly they could enjoy life without feeling they had to start giving away assets or locking them away in schemes so as to avoid tax.

An estate worth £1 million or even £2 million may sound like a lot of money, but once you take away the value of the house - perhaps £½ million in the South East - the remainder doesn’t leave an income sufficient to lead an extravagant lifestyle. It is certainly not enough to give money away without a care as to that the future might hold. The threats of inflation, longer life expectancy, rising long term care costs and uncertain investment returns lead me to advise my clients to plan for the worst case in each of these scenarios.

More people than not end up shelving the inheritance tax mitigation planning, seeing that they are between a rock and a hard place; enough money to have a problem, but not enough to eliminate future financial concerns.