Government should encourage people to pass on wealth during their lifetime

Here’s why the current inheritance tax system needs an overhaul to bring it into line with shifts in social trends and encourage lifetime gifting.

Research commissioned by wealth manager Quilter shows that younger generations who receive ‘lifetime gifts’ from their parents and grandparents benefit more than those who don’t receive an inheritance until the death of their relatives.

The research shows that more than 60% of those who receive money from living relatives say it makes a substantial difference to their lives, compared with 42% of those who inherit on death.

The principal reason why people make lifetime gifts is to help their younger family members buy a first property. As a consequence, four fifths (81%) of respondents who had received money from a living relative owned their own home, compared with 63% of those who had not received anything.

A recent report from the Office for National Statistics shows how much less likely 20-somethings are to have left home compared with 20 years ago. For instance, in 1997, 25% of 18- to 34-year-olds were living with their parents; by 2017 that proportion had risen to 32%. Living with parents is now the most common arrangement for this age group.

There is plentiful evidence to show how much more important financial support from the bank of mum and dad (or grandparents) has become over the past two decades. A quarter of all homes bought in 2018, and almost 60% of those bought by under-35s, were backed by the ‘bank of Mum and Dad’, according to Legal & General research.

Quilter points out that the current tax rules encourage older people to wait until death before their assets are passed on, in that pension benefits can be inherited free of tax if the pension holder dies before age 75. Similarly, family homes worth up to £1 million may be exempted from inheritance tax (IHT) by April 2020.

“The tax system has, in essence, encouraged people to pass on wealth when they die. The annual IHT gifting allowance has remained at £3,000 since 1981. Had the annual allowance tracked inflation, it would’ve been permissible to gift £11,296 per tax year in 2018, according to the Bank of England inflation tracker,” comments Rachel Griffin, a tax planning expert at Quilter.

Although gifts made by people fall out of their estate provided they live for another seven years, Griffin argues that this rule is “basically a perverse game of Russian roulette, as it’s a gamble that you will survive”, and should be done away with.

As things stand, research from L&G and the Centre for Economic and Business Research (CEBR) carried out in 2018, indicated that around a fifth of parents and grandparents leave themselves financially worse off in order to give money away to younger family members.

Quilter points out that the Office for Tax Simplification is currently preparing a second paper as part of the government’s IHT review. It argues that this offers an opportunity for reform of the lifetime gifting rules to make lifetime gifts more attractive from an IHT perspective.

“We know there are lots of people who would like to pass wealth down to their families while they are still alive. Increasing the IHT gifting annual allowance would encourage some of that money to cascade down the chain, giving a welcome financial boost to younger generations,” says Griffin.

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