Rishi's Election Unicorn

It was reported in The Sunday Times this weekend that Rishi Sunak is contemplating a cut in the IHT rate, possibly as a strategy to gain voter support and differentiate from Labour policies.

I speculated back in June that there was a strong likelihood of IHT being scrapped, particularly given its potential appeal to voters in crucial Conservative battlegrounds.

I maintain my view that this could feature prominently in the Conservative Election manifesto.

However, it's worth noting that such a change is unlikely to see the light of day under a Labour government.

Given these developments, I thought it would be timely to debunk some common myths and misconceptions surrounding IHT (since it could be the last time I get to write about them!) and delve into the implications for those who have already undertaken IHT planning, should the tax be abolished.

Inheritance Tax Myths and Misconceptions

Navigating the complexities of Inheritance Tax (IHT) can often feel like a minefield, rife with misconceptions and misunderstandings. Here, I aim to debunk six common myths about IHT:

1. My Spouse/Partner Will Inherit Everything I Own Free of IHT

A widespread assumption is that if you're married or in a civil partnership, your entire estate will pass to your surviving spouse or partner free of IHT. However, this isn't necessarily the case if you don't have a will.

For married individuals with an estate exceeding £250,000 and children, the children may be entitled to a portion of the estate. The larger their share, the greater the likelihood of IHT being charged.

2. ISAs Are Free of IHT

Contrary to belief of many, ISAs are not exempt from IHT. The assets within an ISA will be included in the value of your estate, and you'll be liable for tax on any amount exceeding the current IHT threshold of £325,000. However, it's now possible to transfer your ISA to your spouse upon death (before ISAs had to be sold on death). Some companies also offer AIM ISAs, which can be IHT-free if the shares are held for at least two years (see below!).

3. Giving Your Home to Your Children Will Save IHT If You Survive for 7 Years

If you transfer your home to your children but continue to live there, HMRC may deem this a "Gift with Reservation." This means that although you've transferred the asset, you haven't relinquished your use of it.

Consequently, your estate would be treated as if the asset were still part of it upon your death.

This could also result in your children facing Capital Gains Tax if the property appreciates in value and they later sell it.

4. You Can Only Gift £3,000 Per Tax Year Without Incurring an Immediate Tax Bill

This is incorrect. Individuals are free to give away as much money as they like to people such as family members without an immediate IHT charge. The only time IHT may apply is if you die within seven years of making the gift.

5. Taper Relief Applies to All Lifetime Gifts After 3 Years

Again, this is a misconception. Taper relief, which potentially reduces the level of tax from 40% on gifts, only applies to amounts given away that exceed £325,000.

So, if the total value of gifts made during the last seven years of your life is less than £325,000, no taper relief will be available upon your death.

6. Assets Abroad Are Not Subject to UK IHT

This is incorrect. If you are a UK resident and domiciled here, your entire worldwide estate could potentially be subject to IHT, regardless of where the assets are located.

Should IHT remain, understanding these myths and the actual rules surrounding IHT can be crucial for effective financial planning.

Previous IHT Planning: What Happens If the Rules Change?

As discussions around potential changes to IHT gain momentum, it's crucial to consider the impact on existing IHT planning strategies.

From AIM shares and Business Property Relief to Family Investment Companies and Trusts, let's consider how these could be affected.

AIM Shares

Alternative Investment Market (AIM) shares have long been touted as an IHT-efficient investment. However, it's worth noting that these shares often trade at a premium, estimated to be around 30%.

If IHT rules change, we could witness a significant sell-off in this market as investors scramble to adjust their portfolios. Such a move could deflate the inflated values and disrupt the AIM market considerably.

Business Property Relief

Business Property Relief is a significant area where lower-risk, cash-plus-type assets are often marketed to the elderly as an IHT planning tool.

If IHT were to be abolished or significantly altered, there could be a rush to liquidate these illiquid investments. However, companies in this space typically use new cash inflows to fund redemptions, so we might witness a gradual unwinding rather than a sudden collapse.

Family Investment Companies

Many wealthy families are being advised to set up Family Investment Companies as a means to circumvent IHT and pass assets down the generations. Personally, I've always been sceptical of these structures, viewing them more as a tool for wealth managers to retain assets under management.

Unwinding these could prove to be a complex, cumbersome and costly.

Trusts

Trusts have been a well-established route for IHT planning for years. To make a trust IHT-efficient, the settlor must genuinely give away the assets.

While trusts may not offer the best tax efficiency, they are a popular choice due to their effectiveness in generational planning.

If IHT laws change, those who have tied up assets in trusts may find themselves regretting the decision, as unwinding these structures could be difficult, if not impossible.

Life Cover

Joint life second death plans are often set up as part of an IHT planning strategy.

If IHT is abolished or reduced, it's likely that many of these plans will be cancelled, leading to potential disruptions in the life insurance market.

In summary, while IHT planning has been a staple in financial and estate planning, potential changes to the tax could have far-reaching implications.

Whether you've invested in AIM shares, opted for Business Property Relief, or set up a Family Investment Company, it's crucial to stay informed and possibly seek professional advice to navigate the evolving landscape.