T | a-zofinequality

Trusts and inheritance tax

According to research by the Kings Court Trust, an unprecedented £5.5 trillion will pass between generations over the coming 30 years [1]. This has been driven by a boom in Britain’s net wealth since the 1980s, almost quadrupling between 1995-2016, thanks to soaring property prices and generous defined benefit pensions [2]. This wealth accumulation has predominantly been captured by older generations, especially the “baby boomers” born shortly after World War II. Over-65s owned 36% of the UK’s household wealth as of 2016, up from 28% a decade earlier, and one in five of them are millionaires [3]. Younger generations have found it much more difficult to accumulate wealth in the same way, with much lower rates of homeownership. Pension enrollment is higher for younger cohorts, but typically in less generous defined contribution schemes [4]. As a result, how much wealth younger people end up having will be substantially defined by how much they inherit.

Inheritance tends to reproduce wealth inequality over time. According to the ONS, based on data from 2014-16, 7% of those in the wealthiest 20% received an inheritance of £1,000 or more compared to just 1% of those in the bottom 20%, and the median amount received by the top 20% was £35,000 (mean £92,100) compared to a median of £3,000 for the bottom 20% (mean £8,500). Looking at recipients by their position on the income distribution instead showed a less unequal distribution of inheritances, emphasising that it is wealth in particular which tends to be passed on. Despite their smaller size, inheritances tended to be most significant for the least wealthy 20%, accounting for 44% of their net worth compared to 5% for the top 20%. This suggests that inheritances may reduce relative, though not absolute, wealth inequality [5].

Voluntary taxes for the 1%.

Former Chancellor Roy Jenkins once described Inheritance Tax as “a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue.” [6] His quip still rings true today: the truly wealthy have so many avenues through which they can legally avoid Inheritance Tax that it is possible to mostly or entirely avoid any liability, unless they simply lack an interest in preserving their wealth for their successors.

To take one example: in 2016 the 6th Duke of Westminster passed away, leaving his son, Hugh Grosvenor, the title of 7th Duke of Westminster and an estate estimated to be worth more than £9 billion. If this inheritance had been taxed the new Duke and his sisters would have been liable to pay at least £3.6 billion to HMRC (40% of £9 billion; the tax-free allowance would have been an insignificant portion of an estate so large). Actual Inheritance Tax receipts for the 2015/16 financial year were £4.7 billion, so if this one estate had been taxed it would have increased Inheritance Tax revenue by upwards of 77%. However, no tax liability was incurred because the Dukes of Westminster are not the legal owners of the Grosvenor Estate. Instead, the estate is held in trust, owned and operated by a group of trustees on behalf of the Duke and his relatives [7].

A trust is a legal entity which owns, manages, and disposes of assets on behalf of others. Assets held in trust, therefore, are owned by the trustees and not the beneficiaries. This can confer some substantial tax privileges: ‘bare trusts’, where assets are passed to a beneficiary once they turn 18, are exempt from Capital Gains Tax and Inheritance Tax [8]. Trusts can also be used to reduce the size of a person’s estate for Inheritance Tax purposes, since when someone puts assets into a trust they are legally relinquishing ownership of those assets [9]. The liability of qualifying transfers into trusts is progressively reduced, reaching zero if the person making the transfer survives for at least seven years.

The Grosvenors receive an undisclosed income from their estate, but no Inheritance Tax was owed when the 6th Duke died because, technically, there was no change in the ownership of the estate. All that changed was who benefited from the trust [10]. The proceeds they receive from the trust may still be taxable income, so they are not completely avoiding any form of taxation. However, the preservation of family wealth between generations, which Inheritance Tax is supposed to tackle, occurs tax-free thanks to the trust.

Trusts are not the only, nor even the most common, method of avoiding or reducing Inheritance Tax liabilities. The size of an estate can also be reduced by making gifts; individuals can give away up to £3,000 a year tax-free (effectively £6,000 for a couple) and unused allowances can be carried forward to the next year. Ownership of private businesses (including unquoted shares) and agricultural property is also exempt from Inheritance Tax [11]. The largest reliefs on Inheritance Tax are simple exemptions for transfers between spouses and civil partners, or to eligible charities and clubs [12].

Inheritance Tax is only charged at all on parts of an estate that exceed the tax-free threshold of £325,000. That threshold can be increased to £475,000 if the deceased owns a home and gives it to their children or grandchildren (set to rise to £500,000 for the 2020/21 financial year), and spouses or civil partners can leave any unused allowance to their partner, effectively creating a joint threshold for couples of up to £950,000 (£1,000,000 next financial year) [13]. These thresholds are high enough that most people do not leave an estate large enough to be liable to pay any Inheritance Tax - in 2016/17, only 4.6% of UK deaths resulted in Inheritance Tax being charged [14].

Nevertheless, many families take preventative steps to reduce or eliminate their liabilities. According to research carried out in 2018 by the insurer Direct Line, nearly 7 million parents have transferred a total of £227 billion to their children early in an effort to reduce the size of their estates. 9% of parents have placed assets into a trust, with 20% of people with life insurance policies putting that into a trust [15].

Inheritance Tax hurts the non super rich.

Despite large tax-free allowances Inheritance Tax liabilities are rising with receipts more than doubling since 2009/10, largely due to property values rising while the basic threshold has remained the same [16]. For many in London and South East England, simply owning a home can cause an estate to become liable given how high property prices are in these regions [17]. More than half of Inheritance Tax liabilities came from estates in these regions in 2015/16 [18]. Gifting a home can lead to it being exempt from Inheritance Tax is enough time passes before the owner passes away, however this can create a difficult decision, especially given the difficulty of moving in an inflated property market.

The costs of social care, which are not covered by the NHS, became a salient topic during the 2017 general election campaign due to Conservative proposals to reform the system which proved so unpopular they were abandoned and have never been implemented. The current system is dubbed the “dementia tax” by the Alzheimer’s Society as people with dementia require a great deal of social care and so are particularly affected by the costs - averaging an estimated £100,000 [19]; the term was also applied to the Conservative proposals.

The existing system is means-tested: if a person has assets of less than £23,250 - excluding their home if they receive care at home; i.e. unless they move into residential care or a nursing home - then their local authority will fund all or part of their social care costs. This means people who own a home but who need to move out for care very likely to exceed the limit and to have to pay for their care, which can mean exhausting savings, selling their home, or deferring payment until after they pass away when it is taken out of the value of their estate. The Conservatives proposed to raise the means-tested limit to £100,000 but to include the value of a person’s home for everyone, even those still living and receiving care at home [20].

The costs of social care and any future reforms pose a serious challenge for many elderly people and their families. Given the importance of inheritance as an intergenerational wealth transfer, as described above, social care costs are arguably an unfair burden likely to unequally penalise some families. People looking to manage their wealth and plan in advance to avoid Inheritance Tax liabilities may be constrained by the need to save money to possibly pay for social care.

Tax people while they are alive.

About 3% of estates were valued at over £1 million, and these accounted for 72% of Inheritance Tax charges as of 2016/17. However, the composition of assets is different for millionaire estates: more likely to include securities and other assets with attract reliefs such as Agricultural Property Relief and Business Property Relief. Estates valued at less than £1 million predominantly consist of just residential property and cash [21]. The wealthy, broadly speaking, do pay Inheritance Tax but also benefit from exemptions and reliefs.

Inheritance Tax is extremely unpopular. YouGov polling from 2015 found Inheritance Tax to be the most unpopular tax polled, with 59% of respondents calling it ‘unfair’ compared to just 22% saying it was ‘fair' [22]. Despite the fact that most people will not incur an Inheritance Tax liability, there seems to be a prevalent feeling that it is undesirable to tax estates upon their owner’s death.

In 2018/19 Inheritance Tax raised £5.4 billion, less than 1% of total tax revenues of £619 billion [23]. This suggests that it is hardly a vital or irreplaceable source of revenue for the government; at first glance, it should not be too difficult to reform or replace Inheritance Tax with more consistent taxation of wealth without causing a net loss of revenue. For example, Labour’s 2019 plans to tax capital gains and dividends at the same rates as income tax were projected to raise an additional £14 billion [24]. Scrapping Inheritance Tax and replacing it with more efficient and continuous taxes on wealth could be a policy that is viable, effective, and popular - a rare combination!

Ideas for continuous taxation of wealth have been floated in the UK before. The most obvious recent example is the so-called ‘mansion tax’, which both Labour and the Liberal Democrats proposed in 2015 - an annual levy on homeowners with properties valued at more than £2 million [25]. In 1974 Labour were elected on a manifesto which included a promise to introduce an annual wealth tax; this was never introduced, though they did implement a Capital Transfer Tax on large transfers of wealth such as gifts which was repealed by the Conservatives after they regained power in 1979 [26]. The Mirrlees report reviewing the UK’s tax system as of 2011 recommend against taxing stocks of wealth, but approved of the taxation of large transfers of wealth [27].

An even more radical policy would be an explicit ‘wealth tax’ on large accumulations of assets. This is a proposal that seems to be gaining traction in the US, with leading Democratic presidential candidates Bernie Sanders and Elizabeth Warren backing such a policy. Warren’s proposal would tax individuals with assets totalling more than $50 million at a rate of 2%, with a higher rate of 6% for billionaires. Sanders’ proposal would start at 1% for fortunes exceeding $32 million, gradually rising to 8% for those with more than $10 billion [28].

Even without explicitly taxing wealth in terms of accumulated fortunes or estates, wealth could be effectively and continuously taxed by simply focusing on certain assets. Private pensions, property, and financial assets combined account for 91% of privately-owned wealth in the UK [29]. Even just improving the existing system of taxes on such assets - for example by reviewing tax breaks enjoyed by private pension schemes, reforming Council Tax and business rates to better reflect property values and ownership, and aligning Capital Gains Tax with Income Tax - would be a significant step towards effective taxation of wealth.

1 https://www.kctrust.co.uk/partner-blog/blog/2018/wealth-transfer-in-the-uk-research-highlights

2 https://russellinvestments.com/uk/blog/intergenerational-wealth-introduction

3 https://www.ft.com/content/c69b49de-1368-11e9-a581-4ff78404524e

4 https://www.ft.com/content/c69b49de-1368-11e9-a581-4ff78404524e

5 https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/articles/intergenerationaltransfersthedistributionofinheritancesgiftsandloans/2018-10-30

6 https://www.telegraph.co.uk/finance/personalfinance/tax/2924336/Its-much-better-kept-in-the-family.html

7 https://www.theguardian.com/money/2016/aug/11/inheritance-tax-why-the-new-duke-of-westminster-will-not-pay-billions

8 https://www.gov.uk/trusts-taxes

9 https://www.moneyadviceservice.org.uk/en/articles/using-a-trust-to-cut-your-inheritance-tax

10 https://www.tatler.com/article/hugh-grosvenor-wealth

11 https://www.oldmutualwealth.co.uk/globalassets/documents/literature-library/omwla/inheritance-tax/omw_sk0653_your_guide_to_uk_inheritance_tax_and_trusts.pdf

12 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/731610/Inheritance_Tax_National_Statistics_Commentary.pdf