Laura Howard, Wednesday March 05, 2008
Chancellor Alastair Darling has vowed to double the Inheritance Tax (IHT) threshold to a combined £600,000 in this week's Budget - but critics claim the proposed changes are largely cosmetic. So how much better off will you be as a result? We take a look
In his Pre-Budget report last October, Chancellor Alistair Darling announced significant changes to the rules surrounding Inheritance Tax (IHT) - taxes paid on the transfer of assets on death. Critics claimed that the proposals were largely cosmetic and added nothing to existing tax structures but the Government claims that the changes will see most couples' tax-exempt limits double.
If, like most people, you're not sure how the new IHT changes will affect you, now's a good time to start from the beginning.
Why has IHT come under the spotlight?
Inheritance tax (IHT) was originally designed to target the super-rich but record numbers of 'average' working people have been dragged into the IHT net in recent years as a result of soaring property prices.
Recent research from pension and investments giant Scottish Widows reveals that around one in three estates are currently liable for IHT, with average household wealth estimated to be £258,000. The Conservatives took full advantage of the public pressure on Darling to raise the IHT thresholds with proposals to increase the current limits to a combined £1m.
The current rules
IHT is currently charged at a flat rate of 40% on any assets left on death over the value of £300,000. From April, this threshold will increase to £312,000. Married couples or those in civil partnerships receive a total exemption on IHT when passing assets between each other.
Until now if one spouse died and left everything to the other, while no tax would be payable, the nil-rate band has been 'used up'. So when the surviving spouse dies, only the first £300,000 of the estate is exempt from IHT when being passed onto heirs - usually children. If the estate has grown in value over this time and is now worth, for example £1m, tax would have to be paid on the remaining £700,000 by the children.
What changes were made?
The new changes allow the £300,000 nil-rate band to be carried over between married couples - giving the surviving spouse a total IHT-free allowance of £600,000. This means that when the estate is finally passed to their children, the first £600,000 is tax-exempt rather than the first £300,000. So, on the same mortgage-free £1m home IHT would only be payable on the first £400,000, not the first £700,000.
Why are the changes a good thing?
Under the old IHT regime, some people got round the rules by squirreling away £300,000 in a trust to ensure fewer assets are passed to the surviving spouse in the first place on which they would eventually use their single £300,000 nil-rate band. For those who never got around to IHT planning, the proposed changes are good news as the benefit will automatically apply. It also means avoiding costly legal fees associated with setting up the trust.
It's estimated that the change will automatically benefit some 12 million married couples and people in civil partnerships, as well as a further 3 million widows and widowers.
What's the downside to the changes?
Some industry experts claim the changes don't go far enough. Many point out that existing tax planning already allowed families to take advantage of a £600,000 limit. Accountants BDO Stoy Hayward claim a fairer solution would be to increase the IHT exemption threshold to at least £500,000 to ensure that the tax hits those it was meant to, not moderately affluent homeowners.
"Alistair Darling should consider changing IHT from a slab tax to a progressive tax where different percentages are paid above certain thresholds," says BDO Stoy Hayward director Ian Miles.
Will there be further tax breaks in The Budget?
IHT isn't the only tax that is increasingly affecting more modest earners and many are calling for sweeping changes to the Stamp Duty system. Stamp Duty is currently payable on the entire value of any property worth £125,000 or more - yet the average house price in February was £196,649, according to Halifax.
As a result, the average Stamp Duty liability on the typical house price is just under £2,000 - a crippling sum for the majority of homeowners.
More on this year's Budget:
This year's Budget laid bare
Alison Cork's Budget warning for homeowners
