Has Labour’s first budget thrown up some interesting inheritance tax (IHT) planning points? The devil will be in the detail, but here are some early thoughts for you.
Pension Pots
Previously your heirs could inherit your remaining pension pot free of IHT. If you died before age 75 the pot was completely tax-free. If you died after age 75 money taken out would be assessed for income tax.
The income tax rules have not changed but the IHT has. Your spouse can still receive your remaining pension pot free of IHT. However, on your spouse’s death any remaining value will be included when calculating how much IHT is due.
And there is more. If your pension pot pushes the estate value above £2m, the additional IHT allowance (available to protect properties up to £1m in value) starts to reduce.
This change comes in to force on 6 April 2027. The change of law needed to implement it is complicated, hence the delay. That leaves the door open for it to be abandoned. It would be easier to treat deaths before age 75 the same as deaths after age 75. I would not be surprised if that were the case.
This change is not good news. However, here are some planning ideas that could mitigate its effect.
Buy an annuity
You could reduce the value of your estate by buying an annuity. An annuity means you swap some or all of your pension pot for a guaranteed income. Annuity rates are much more attractive than they have been for a long time – you probably need to live 20-25 years to be sure of getting your money back via an annuity.
You would pay income tax on the income. But is it better to pay (potentially) less tax now to avoid more tax later?
If you don’t need the income, you could gift it (an advance inheritance?) to family, friends or anyone else. And the gift would probably be IHT free under the “gifts out of income” rule.
Or you could turbo charge the value of the income by buying life assurance written in trust to provide a significant IHT-free lump sum to your loved ones, once neither you nor your spouse are around.
Or just take more out?
Perhaps you don’t like the annuity idea, there are good reasons not to. How about just taking more income directly from your pot?
Does taking extra, paying 20% on it, and doing some thing useful with it (see above) make more sense than not putting it to good use and paying 40% tax on it later?
What if you could pay towards your children’s education, medical or housing costs? Even paying 40% now and putting it to good use, might be an attractive idea.
Moving abroad
The second big IHT change is the change to “non-dom” rules. The UK government wants more tax from wealthy foreigners. I will not attempt to explain the rules here, they are somewhat irrelevant to my point.
What I want to highlight you can read in THIS FT ARTICLE. The FT implies a loophole has been created. That is not correct. Instead the change means that, if you are UK born and bred, and are an expat (or are thinking about it) then you might be in for a tax break.
Prior to this budget it was very difficult for someone born and bred in the UK to avoid paying UK IHT on all their assets wherever they lived. If you retired overseas and maintained a presence in the UK – a property, car, bank account etc. – the UK would look to apply IHT to everything you had accumulated wherever you had chosen to live.
That will no longer be the case.
If you left in 2014 or earlier, your overseas assets will no longer be subject to UK IHT. If you leave now, in 2034 the same will apply to you. If IHT is important to you then this looks like an attractive opportunity. HERE IS A LIST of countries that don’t have IHT – there might be higher and different taxes than here.
Current and future expats (who move to an IHT free country) should now consider selling up in the UK and moving that money out of the UK. If that is not possible, spending your UK assets first to avoid 40% IHT looks like a good idea.
But that is not all, as the article makes clear.
After 10 years away you can return and not pay any UK tax on overseas income and assets for the first 4 years you are back. And full UK IHT will not be charged until you have been back for 10 years.
Reflections
The first – there is more to life than taxes and the avoidance of them. These planning ideas have a degree of finality about them. It will be difficult to retrace your steps without pain and upset.
The second – why have IHT at all? A serious list of countries do not believe it necessary. IHT is proving to be ever more divisive. It is generally seen as an unfair tax (even by those who don’t pay it), levied on money that has already been taxed. In turn it encourages avoidance tactics and pushes up the value of “IHT free” assets.
Even worse, the government may have achieved a double whammy – annoyed a lot of people and not increased the tax take.
As attributed to Jean-Baptiste Colbert (1619–83) the French statesman:
“The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”
Effective taxation is an art form. Is what we have toddlers with crayons?