The role of protection in estate planning

The role of protection in estate planning

HM Revenue & Customs collected nearly £5bn in inheritance tax (IHT) in the 2016-17 tax year, a figure up 4 per cent on the previous year. 

The government has now launched a review to simplify the IHT regime and make it fit for purpose, and protection can help ease the tax burden for younger generations. 

The review, which is being undertaken by the Office of Tax Simplification (OTS), will look at a number of different elements of the IHT regime. As well as administrative issues such as the process of submitting returns and paying any tax due, it will also assess the rules around estate planning and whether these distort taxpayers’ investment and financial planning decisions.  

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Opportunities for simplification

The current rules certainly offer plenty of opportunities for simplification. As well as complexities around the different planning devices, recent changes have created further layers of complication.

A good example is the residence nil-rate band (RNRB), which came into effect in April 2017. This gives individuals an additional nil-rate band (£125,000 in 2018-19) when passing on the family home to direct descendants. Increasing each year, this will reach £175,000 in 2020, enabling a married couple to pass on an estate worth £1m without incurring IHT.

Although the RNRB enabled the Conservative party to tick off its manifesto pledge of a £1m inheritance tax allowance, it did little to make planning straightforward. This was demonstrated by a survey conducted by Old Mutual Wealth ahead of its introduction, which found that 70 per cent of people did not understand how it worked.

“The rules are complex but also incredibly restrictive, as you can only use it when leaving your home to a direct descendant,” explains Rachael Griffin, tax and financial planning expert at Old Mutual Wealth. “This does not sit comfortably with today’s society where blended families are common, nor is it aligned with the concept of testamentary freedom, which is in place in England and Wales.” 

Modernising the rules

As well as making the rules easier to understand, the review will also offer an opportunity to modernise some of them. As a bare minimum, Ms Griffin would like to see some of the IHT exemptions brought up to date. For example, the annual gifting allowance of £3,000 has remained unchanged since 1981. If it had kept pace with inflation, it would have increased to £10,932 in 2017. 

“Reports on intergenerational wealth show that this is largely held by the older generation,” she adds. “With allowances stuck in the 1980s, their hands are tied when it comes to passing this wealth on tax efficiently to the younger generations.”

Another change that many would like to see is an equalisation of the rules between married and non-married couples. Currently, an IHT exemption only exists where assets are left to a surviving spouse or civil partner, leaving an unmarried partner potentially facing an IHT bill on assets they may have shared for many years with the deceased. Under the current rules, marriage is the only way to avoid this IHT charge, as comedian Ken Dodd demonstrated when he secretly married his partner of 40 years a couple of days before he died.