Alert issued regarding how tightening inheritance tax may hinder economic expansion
The UK government's proposed changes to inheritance tax (IHT) rules could have far-reaching consequences for the economy, family wealth distribution, and the functioning of the "Bank of Mum and Dad."
Effects on the UK Economy
The proposed reforms, such as capping the value of lifetime gifts that can pass tax-free and including certain assets like inherited pensions within IHT, risk undermining the property market. The UK housing market heavily relies on parental financial help, which facilitates property purchases. If large parental gifts become subject to IHT, this could reduce available funds for deposits and dampen house prices and transaction volumes, potentially leading to broader negative economic effects.
Increased IHT scope might initially raise government tax revenue from estates and gifts. However, capping lifetime gifts could alter behaviour, with families retaining assets longer or finding ways to circumvent the tax, potentially reducing long-term revenue. Moreover, the administrative burden on tax authorities and trustees is expected to rise due to more complex reporting and compliance requirements, especially with inherited pensions coming under IHT rules from 2027.
Effects on Family Wealth
Stricter IHT rules on lifetime gifts and the shift to a residence-based system (replacing domicile) may limit tax exemptions for some spouses and civil partners, particularly international couples or those with mixed domicile/residence status. This could constrain families' ability to transfer wealth tax-efficiently across generations.
Families might delay or reduce financial gifts to children, leading to less intergenerational wealth support. This can impact wealth accumulation for younger generations and may induce wealthier individuals to consider relocating abroad to avoid high IHT rates, possibly reducing wealth retention within the UK.
Effects on the Bank of Mum and Dad
If lifetime gifts are taxed or capped, parental help to children—especially for costly goals like property deposits—would decrease. Given the rising costs of living and housing, this reduction may have a pronounced adverse effect on young adults’ ability to enter the housing market or gain financial independence.
New rules may lead parents to seek alternative methods to provide support without triggering tax liabilities, such as loans or non-monetary gifts, increasing complexity and administrative challenges for families and HMRC.
From a Treasury perspective, changes would need to be balanced against the fact that these gifts allow for money to pass through the generations. The unintended consequence of taxing gifts could have a negative impact on the property market and number of property transactions.
According to The Guardian, this change is being considered as a means to plug a £40bn fiscal hole in the public purse. Younger family members can put the gifted money to work, buying homes and spending, which brings in taxes and boosts economic activity. However, the money available to the next generation may decrease due to taxing gifts, which could affect economic activity.
Sarah Coles, head of personal finance at Hargreaves Lansdown, suggests that Labour may "come to regret" making complex changes to inheritance tax in the autumn. HMRC could face challenges in policing a cap on the amount of cash or assets individuals can donate. A change in the rules could stymie this flow of cash, which could have an impact on growth. Some people may find ways to avoid reporting gifted money or items to get around the cap, leading to potential revenue loss and administrative challenges.
There could be a substantial amount of extra paperwork associated with a cap on gifts. Changing taper relief could introduce a "cliff edge" system, where people who die one day short of seven years could be "hit with a huge tax bill". Mel Stride, the Conservative shadow chancellor, believes that those who want to pass something on to their loved ones shouldn't be punished by more taxes from Labour.
The UK Treasury is considering changes to the rules that allow Brits to pass on assets to younger family members tax-free over a seven-year period. The implications of these changes on family wealth, the economy, and the Bank of Mum and Dad warrant careful consideration and balanced decision-making.
- The changes in inheritance tax rules might potentially impact personal-finance strategies for families, restricting their ability to transfer wealth tax-efficiently across generations.
- The proposed increase in the scope of IHT and complex reporting requirements could add to the administrative burden on tax authorities and trustees, particularly regarding inherited pensions.
- Businesses relying on parental financial help for property purchases might find a reduction in available funds for deposits due to taxed or capped parental gifts, which could negatively affect house prices, transaction volumes, and overall economic activity.
- The higher taxes on inheritance could lead to changes in family's financial behavior, with a possible decrease in their personal-finance support to children, potentially impacting the wealth accumulation of younger generations.
