A new report from the Institute of Fiscal Studies, 'Reforming Inheritance Tax', suggests that abolishing Inheritance Tax will return £1 million to the richest one per cent of UK estates, while losing the Treasury £7 billion in tax revenues.
The Institute of Fiscal Studies' (IFS) new report sets out issues with the Inheritance Tax (IHT) system and examines options for reform and the distributional impacts of reforming or abolishing the tax.
As the IFS points out, ironically, the Inheritance Tax (IHT) is arguably the UK’s most disliked tax. A recent YouGov poll found that 20% of people deemed IHT ‘fair’. This is compared with almost 60% for National Insurance Contributions.
Strikingly the IFS concluded that the current cost of abolishing IHT would be £7 billion. Around half (47%) of the benefit would go to those with estates of £2.1 million or more at death and those who make up the top 1% of estates and would benefit from an average tax cut of around £1.1 million.
1. Inherited wealth is growing and set to continue to grow compared with earned incomes and it will have a growing impact on inequalities by parental background.
- Those with the wealthiest fifth of parents are set to rise from averaging 17% of lifetime income for those born in the 1960s, to averaging 30% of lifetime income for those born in the 1980s.
- If the annual flow of non-spousal inheritances next year was equally shared across those aged 25, this would imply each receiving around £120,000.
2. Exemption thresholds, which allow many couples to pass on up to £1 million tax-free, mean that the share of deaths resulting in IHT is small, at around 4% in 2020–21, but a larger and growing proportion is potentially affected by the tax.
- By 2032–33, one in eight people (12%) will have IHT due either on their death or their spouse or civil partner’s death.
3. IHT revenues are small, at £7 billion (or 0.3% of GDP) a year.
- However, the IFS forecasts that by 2032–33 they will rise to just over £15 billion in today’s prices (0.5% of GDP).
- It is of growing importance that this tax is well-designed.
4. The current cost of abolishing IHT would be £7 billion.
- Around half (47%) of the benefit would go to those with estates of £2.1 million or more at death.
- The top 1% of estates would benefit from an average tax cut of around £1.1 million.
- The 90% or so of estates not paying IHT would not be directly affected by such a reform.
5. There are several problems with the current design of inheritance taxation.
- Reliefs for Agricultural and Business assets and certain classes of shares, and the total exemption of pension pots from IHT, open up channels to avoid the tax.
- They are consequently costly and inequitable and distort economic decisions.
- The Residence Nil-Rate Band (RNRB), which gives special treatment to property passed to direct descendants, raises similar types of problems and is of greater benefit to those in London and the South.
- There is a clear case for eliminating the special treatment of all of these types of assets.
6. Abolishing agricultural and business reliefs and bringing pension pots within the scope of IHT could raise up to around £1½ billion a year.
7. Four-fifths of the tax revenue from reform to business relief could be captured just by capping the relief at £500,000 per person, rather than outright abolition.
- Most business wealth is concentrated among those with high wealth, so the fiscal cost of an additional half a million pounds threshold for business wealth would be low, though the special treatment would remain unfair and distortionary.
- Around 90% of business wealth bequeathed is given as part of an estate worth over £2 million.
8. Removing the Special treatment for residential property, by abolishing the RNRB (currently set at £175,000).
- Extend the nil-rate band from £325,000 to £500,000. This would cost around £700 million a year and hold the proportion of deaths resulting in IHT down at around 4% while making the tax system fairer.
9. A reform that capped agricultural and business reliefs, brought pension pots within the scope of IHT and abolished the RNRB could fund an increase in the nil-rate band to around £525,000 or a cut in the IHT rate from 40% to around 25%.
10. Increasing the nil-rate band to hold the share of deaths resulting in IHT down at its long-run average of 4% would require a nil-rate band of £380,000 and cost around £900 million a year.
- The cost of limiting the scope of the IHT system in this way would grow over time, reaching £2.7 billion by 2032–33.
11. Levying Capital Gains Tax (CGT) at the point of death would raise around £1.6 billion a year.
- Levying Income Tax on withdrawals from inherited pension pots regardless of the age at which the giver passed away would also raise further revenue.
12. IHT as currently designed has only a small impact on the distribution of inheritances received and therefore on intergenerational wealth mobility.
- The wealthiest fifth of donors will bequeath an average of around £380,000 per child and pay IHT of around 10% of this amount.
- By contrast, the least wealthy fifth of parents will leave less than £2,000 per child.
13. By the time inheritances are received, wealth inequality is already substantial.
- Inheritances are most often received when people are in their late 50s or early 60s.
- Around the ages of 50–54, children of the wealthiest fifth of parents have an average of £830,000 in wealth.
- Children of the least wealthy fifth have on average £180,000.
- While a reformed IHT could do more to promote intergenerational mobility, big wealth inequalities by parental background already exist before inheritances are received.
Useful guides on this topic
IHT: Main Residence Nil-Rate Band (RNRB)
What is the Main Residence Nil-Rate band? When was it introduced? How does it work? Who can claim it?
IHT Agricultural Property Relief
What is Agricultural Property Relief (APR)? When does it apply? What are the conditions and restrictions of the relief?
IHT Business Property Relief
A guide explaining what is Business Property Relief, when it can apply and pitfalls and planning points.
Client Briefing: Making gifts & IHT
What gifts can you make without triggering Inheritance Tax (IHT)? What are the rules on making tax-effective gifts for IHT purposes?
IFS Report (PDF): Reforming Inheritance Tax