Are inheritance tax rules set to change again?

It’s been another long summer of fiscal speculation. Before thechancellor had even agreed the date for the Autumn Statement, what Rachel Reeves might announce on the big day was already hitting the headlines, as pressure on the public purse continued to tighten.

• Our Services: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

Once again, if the rumours are anything to go by, it’s looking like she has set her sight on wealth taxes, with inheritance tax (IHT) becoming an increasingly likely target. And that’s despite already announcing major changes to the taxation of pensions, businesses and farms on death, last year.

“The chancellor has made clear that she is seeking new ways to raise revenue while keeping her promise not to increase the main taxes such as income tax, national insurance or VAT,” notes Alan Barral, a financial planner at Quilter Cheviot. “Inheritance tax is often seen as an easier lever to pull, and the complexity of the existing rules means there are several areas the government could look to tighten.”

He adds: “Speculation has centred on changes to the seven-year rule and taper relief, the introduction of a cap on lifetime gifts, or restrictions on the generous exemption for gifts made out of surplus income.”

Changes to lifetime gifting

Lifetime gifts currently form the central crux of IHT planning for many families. By gifting money to loved ones while you’re still alive, it’s possible to get money out of your estate and spare them a 40% tax bill. An added plus is that you get to see younger generations enjoying the benefit of your wealth.

Currently there’s no limit on the amount of money that people can give away while they are still alive. For so-called potentially exempt transfers (PETs) to be wholly free of IHT, the only requirement is that the person making the gift survives seven years from the date it was made (although taper relief may reduce the rate of tax payable on gifts that exceed the nil rate band, after three years).

As such, a cap would have a significant impact on families’ ability to plan.

Barral says: “The UK has never implemented such a restriction, and if the cap were set too low, it could have a significant impact on many middle-income estates, particularly in areas where property values alone exceed the current frozen thresholds.”

But in addition to stymieing families’ financial planning, there could be implications for the wider economy.

According to Quilter, retirees are “quietly propping up the next generation”. According to a study conducted by Quilter and the Centre for Economics and Business Research, the typical retiree gives an amount equivalent to more than 10% of their income each year to younger members of their family (an average of £2,500 a year) – either in the form of direct gifts or with payments towards the cost of education.

Even without contributions towards education being taken into account, its calculation suggests grandparents could be pumping as much as £16 billion into the economy each year.

And of course, wealthier retirees could be giving away much larger amounts than the “average”, with many, for example, combining IHT planning with helping younger family members take that difficult first step on to the property ladder.

• Can you afford to give away wealth to cut your IHT bill?
• What to consider before gifting your pension to swerve IHT

In terms of how a cap might work, Madeleine Beresford, a partner in the private client department at TWM Solicitors, says: “It could be that a similar approach is taken as with ‘chargeable lifetime transfers’ into certain trusts, for example, the current rules are if you put more than £325,000 into one of these trusts, there is lifetime inheritance tax of 20%, which is increased to 40% if the donor dies within seven years of the transfer.”

She continues: “With lifetime gifts, this might look similar (i.e. any gifts within a seven-year period are subject to a cap of £325,000 and any in excess of that are subject to lifetime inheritance tax at 20%. After seven years, you can give a further £325,000). Otherwise, it could be a lifetime allowance, similar to pensions, or an annual limit similar to ISAs – presumably either approach would still be subject to the seven-year rule.”

Experts have also been quick to point out that any new cap would inevitably cause administrative headaches.

Barral adds: “Administering a lifetime cap could also be complex, as it would require HMRC to maintain detailed records of gifts over long periods. This could lead to administrative challenges and potential disputes in cases where records are incomplete.”

Other changes to lifetime gifting that the chancellor is thought to be considering are an extension to the seven-year rule – potentially to 10 years – and a removal of tapering on certain lifetime gifts. Both of which could encourage older people to make gifts earlier in their retirement, potentially rushing them into making decisions they may not necessarily be able to afford.

Low-hanging fruit

Another relatively straightforward option that has been mooted in the press is a removal of the gifts from surplus income exemption – this allows you to give away as much as you like, so long as gifts are regular and do not have an adverse impact on your standard of living.

But while this can be an effective way for wealthy families to get huge sums out of their estate – helping pay private school fees each term, for example – it’s currently used by very few families (either as a result of lack of awareness or the level of paperwork that’s required).

Beresford says that rules around deeds of variation could be changed too.

At the moment, the beneficiary of a will can use a deed of variation to change their entitlement and get money out of their estate for tax purposes and pass it on to someone else. “In some cases, the beneficiary may still be able to benefit from the assets, which in any other situation would be caught by the gift with reservation of benefit rules. Limits on ‘reading back for inheritance tax purposes’ could be a possibility,” she says.

She adds: “This has long been described as ‘low hanging fruit’, and there has been speculation that the chancellor could become stricter on the rules here, although it seems unlikely that she would take a wholesale approach. Again, there has been speculation about this in previous Budgets but it has yet to come to pass.”

• Growing tax hike rumours overshadow interest rate cut
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

Of course, it’s impossible to tell which way the chancellor will go come the autumn. But Barral says Reeves has a tough balancing act.

“While these changes would potentially raise additional revenue, they would also intensify concerns about fairness,” he says. “Inheritance tax is already deeply unpopular, and many families feel it penalises those who have worked hard and saved diligently, particularly in parts of the country where house price inflation alone has pushed estates above the threshold.”

Don’t make knee-jerk reactions

While some of these rumours could cause blood pressure levels to spike, advisers generally recommend that people avoid making knee-jerk decisions.

“Acting on assumptions that do not come to be could at best be pointless, and at worst highly regrettable, having led to a tax liability,” warns Beresford. “Inheritance tax planning does not exist in a vacuum, often inheritance tax planning has other tax consequences particularly capital gains tax, and income tax in the case of pensions.”

Barral agrees: “Good financial planning should not be dictated by short-term speculation. Selling assets or rushing into gifts now could cause more harm than good if the eventual changes look very different.”