Chancellor Phillip Hammond recently described Britain’s inheritance tax system (IHT) as being ‘particularly complex’. He is not alone; research by Octopus Investments has found a widespread lack of understanding regarding IHT rules in relation to Isas.
One in two (54 per cent) of those surveyed were unsure as to whether Isas are exempt from IHT, while one in five (21 per cent) incorrectly thought Isas are not subject to death duties. Only a quarter (25 per cent) knew the correct answer, which is that Isa savings and investments form part of a person’s taxable estate and therefore could also be subject to IHT.
The exception to the rule is when Isas are passed onto a spouse on death, thanks to rules introduced in 2014 by former chancellor George Osborne.
Paul Latham, managing director of Octopus Investments, notes that IHT is not just a problem for the ultra-wealthy – families on modest incomes have also increasingly found themselves with a potential liability, largely because of the rising value of their homes. To address this issue the government has introduced the so-called residence nil rate band (RNRB).
In a nutshell, the RNRB, used together with the existing IHT allowance of £325,000 per person (£650,000 for married couples and civil partners), will enable couples with a home to pass on up to £1 million to their direct family free of inheritance tax, once it is fully in place in 2020.
‘With more people set to be liable for inheritance tax each year, it’s clear more needs to be done to educate and raise awareness,’ says Latham.
In an attempt to simplify the rules, the government has ordered a review of IHT in January. Hammond said the review should focus on the technical and administrative issues with IHT, as well as practical issues around routine estate planning and disclosure.
The status of pensions and Isas might also be reconsidered. Since pension freedoms, it has become more tax-efficient to pass on a pension than an Isa, because defined contribution (DC) pensions are free of IHT. Therefore, for those in the position of being able to draw on other assets such as Isas, the pension pot should be the last thing to touch.
In the case of final salary or defined benefit (DB) schemes, however, the benefits stop when your spouse dies. If you both die early, it is simply a case of tough luck. Moreover, if you are widowed or divorced the DB pension will end on your death, with no benefits paid to children or grandchildren.
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