David Cameron is rich. I don’t think this is news to anyone. I suspect there are undiscovered tribes in Papua New Guinea who have seen that Bullingdon Club picture.
And like most rich people, he and his family are keenly aware of inheritance tax, and how to plan for it.
That’s because inheritance tax (or IHT, as we like to call it) has tended in the past to mostly affect rich people.
But the net is widening. Despite government efforts to suggest otherwise, the proportion of estates liable to IHT is set to grow steadily in the coming years.
So if you don’t know what to do about IHT, you’d better start finding out.
Here are a few pointers to get you started…
Inheritance tax – the basics
Inheritance tax is a tax on your estate – ie, everything you leave behind after you die. The value of your estate is totted up and anything over a certain amount (which we’ll cover below) is taxed at 40%. Most assets are included.
There are various exemptions, which I don’t have room to cover here, but which we will be looking at in more detail in future issues of MoneyWeek magazine or reports for subscribers (sign up now).
Currently, you can pass on all of your assets to your spouse or civil partner IHT-free. For assets passed to anyone else, you each have a £325,000 allowance. So in effect, a couple who are married or in a civil partnership can pass on up to £650,000 of assets before IHT kicks in at 40%.
From next April, there’s a new allowance designed to make it easier to pass on the family home IHT-free. It starts at £100,000 per person, and will rise to £175,000 by the 2020/21 tax year. In effect, this increases the joint IHT allowance to £1m, assuming that your family home is worth at least £350,000.
However (unlike IHT) this only applies to direct descendants. It’s very much the “family” home allowance.
If you’re thinking: “that’s a very complicated way to sort-of raise the IHT threshold to half a million per person, and it’s also yet another tax benefit for our already massively overly-tax-advantaged British property market”, then you’d be right.
It’s as if the government doesn’t see the contradiction inherent in complaining about the abuse of tax loopholes, while constantly creating new ones for the sake of political theatre. And then it wonders why voters and journalists seem to find it hard to tell the difference between legitimate tax planning, aggressive tax avoidance and outright tax evasion.
A quick aside here, which I’d be interested to get your thoughts on. It’s things like this that make me wonder about the limits of our current political structure. The problem with the Budget, for example, is precisely the same problem that led to the Bank of England being given independence: the timing of the political cycle took precedence over what was in the best interests of the economy. You’d get a cheeky interest rate cut to boost the “feel good” factor pre-election, regardless of whether it was needed or not.
So maybe what the chancellor should have to do is simply to articulate the end result he wants to see: such as, “fewer middle class people worrying about having to sell their homes to pay IHT bills”. Then the civil service or the Institute for Fiscal Studies or some other neutral-ish group stuffed with brainy technocrats lays out the most practical ways to achieve that goal, and the chancellor either chooses one or scraps the plan.
That way, you get rid of the political theatre. And you also force the chancellor of the day to be honest and transparent about what they want. The Help-to-Buy Isa would never have been introduced, for example, because to get a bunch of neutral, intelligent people to come up with that particular scheme, the chancellor would have had to say: “I want to make it look as though I’m helping with the housing crisis, but only in such a way that doesn’t involve house prices falling”.
The choice of policy is still democratic, but the execution of policy is technocratic and hopefully more competent. Anyway – it’s just a thought.
How David Cameron’s tax planning move could help you
Back to the matter in hand.
One key way to avoid IHT if you have a lot of wealth is to start giving the money away. The tax office is on to this, of course. You can’t just wait until your appointed time is imminent – a full seven years has to pass before a gift is considered to be entirely out of your estate for IHT purposes.
However, the tax rate does reduce on a sliding scale. If you survive the gift by three to four years, the tax rate falls to 32%, then 24% (five years), 16% (six years) and 8% (six to seven years).
This is what’s known as a “potentially exempt transfer” (PET), and that’s what the fuss has been over David Cameron’s mum giving him £200,000. (Labour have also said they’ll look at reviewing this if they get into power – although judging by the public’s general hatred of IHT, they really shouldn’t be messing about with allowances if they want to get voted in.)
Some gifts don’t count towards this. You can give away up to £3,000 in any given year. This allowance can be carried over but only to a maximum of £6,000. Also, gifts of up to £250 don’t count towards this allowance. And nor do wedding gifts – you can give a child about to get married up to £5,000 without it counting as a PET or as part of your annual allowance.
So that’s one way to plan for IHT. There are plenty more, and we’ll be covering them in more detail in future issues of the magazine.
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