The Resolution Foundation, an independent think tank established to improve the standard of living of low-to-middle-income families has called on the government to move to a new structure for charging Inheritance Tax.

The organisation suggests lower rates for estates worth up to £1.5 million. We take a look at the current rates of Inheritance Tax and the new proposals.

Inheritance Tax rates and allowances

There is usually no Inheritance Tax to pay when a net estate is worth less than £325,000, known as the nil rate band, or if everything above this threshold is left to your spouse or civil partner or to a charity or a community amateur sports club.

If your spouse or civil partner died before you and their allowance of £325,000 was not used, then any remaining part of this can be transferred to your estate, making a total nil rate band of £650,000.

If you leave your home to your direct descendants and your estate is worth less than £2 million, then there is an additional allowance of £175,000, known as the residence nil rate band. Again, any part of this allowance not used by your spouse’s estate can be transferred, making a total residence allowance of £350,000. Added to the nil rate band, this makes a potential total allowance of £1 million.

The standard rate of Inheritance Tax is 40%. If you leave 10% or more of your net estate to charity, this is reduced to 36%.

Gifts of cash or valuable items made in the last seven years before death may be liable for Inheritance Tax. Generally, you can give £3,000 away each year, with some exceptions for gifts to family members for events such as weddings. If more than this is given away in the seven years before death, then Inheritance Tax is payable on the sum on a sliding scale, as follows:

Years between gift and death    Rate of tax on the gift

3 to 4 years                                   32%

4 to 5 years                                   24%

5 to 6 years                                   16%

6 to 7 years                                   8%

7 or more                                      0%

Think tank proposals

The Resolution Foundation has proposed returning to a progressive rate structure, with a 20% band for estates valued at between £650,000 and £1 million (for couples) and a 30% band for estates worth up to £1.5 million.

They suggest that the current tax reliefs on business and agricultural properties ‘should be scrapped or heavily restricted’. They feel that these reliefs are only available to a small number of individuals and are one of the main reasons why the effective rate of tax paid on estates worth over £10 million is 10%.

They also suggest taxing inherited pension pots, which they feel are no different to other savings if they are not used to purchase an annuity.

They recommend ending the residence nil rate band, stating:

“The RNRB does significantly reduce how many estates pay any IHT. And it is not as topheavy as Business Relief is, for example, in part because it is at least partially withdrawn from estates worth over £2 million.

“It is hard to argue why main homes should be favoured over other assets among the small proportion of the population that pay IHT – particularly given that these also benefit from an exemption from Capital Gains Tax. And it is hard to argue why transfers to siblings or niblings, for example, should be taxed very differently from transfers to children or grandchildren.

“The RNRB is also complicated, for example due to the well-intentioned downsizing provisions that mean that the relief can apply to non-housing wealth so long as the deceased previously owned a home.”

They also suggest replacing Inheritance Tax with a lifetime tax on recipients. An annual allowance would be permitted, for example, £3,000. There could also be a lifetime allowance, for example, £125,000. Beyond this, a progressive structure could be imposed.

The think tank says: “This approach would have a number of advantages. First, while IHT may only apply to transfers made within seven years of death, a broader tax would potentially include all gifts and therefore could not be avoided simply through giving earlier in one’s life.

“Second, taxing recipients rather than estates would bring practical benefits such as removing the current need for policy to transfer tax allowances within marriages and civil partnerships, which is complicated and unfair on cohabiting couples; and reporting transfers when they are received rather than retrospectively at death.

“But, third, it could also change perceptions of inheritance taxation. The charge levelled against IHT that it is a double taxation of savings would hold less weight if it was explicitly a tax on the income of recipients. And there is greater public support for applying inheritance taxes to people who have previously received inheritances (or otherwise have higher incomes and/or wealth) than for others. Indeed, such an approach would also encourage donors to spread their bequests more widely (to take advantage of per-person tax allowances and tax rates).”

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