Family fortunes: is Inheritance Tax fit for modern families?

With birth and marriage rates falling, the model of the 'traditional' family is quickly changing. Justine McCluskey asks whether Inheritance Tax is fit for modern times.

23rd February 2022

“Maybe you’ll marry, maybe you won’t
Maybe you’ll have children, maybe you won’t
Maybe you’ll divorce at 40, maybe you’ll dance the ‘Funky Chicken’
On your 75th wedding anniversary
Whatever you do, don’t congratulate yourself too much
Or berate yourself either
Your choices are half chance
So are everybody else’s” 
Mary Schmich (later Baz Luhrmann “Everybody’s Free (To Wear Sunscreen)”)

Mary Schmich, the Pulitzer Prize-winning journalist, wrote these words in 1997 as an injunction to her readers to live their lives without regret. Her column, which was reprised in the lyrics of a worldwide hit, provided advice on how to live a happier life and challenged traditional societal expectations, such as marriage and having children.

The Office for National Statistics recently reported that, for the first time, more than half of women in England and Wales are entering their 30s without children. In addition, fewer people are getting married, and those who choose to are doing so later in life than ever before. Many won’t marry at all, with cohabiting couples constituting the fastest-growing family type in the UK. Divorce rates have steadily increased, and more people will have multiple spouses over the course of their lives as a result, while living alone is becoming an increasingly popular choice. Importantly, fewer people are having children, and those who do are very likely to come to parenthood much later than previous generations. 

The common thread running through all these trends is that individuals are increasingly rejecting the ‘traditional’ notion of the nuclear family. And where societal trends go, the law must surely follow if it is to continue usefully serving society. Nonetheless, there is an argument that the Inheritance Tax (IHT) regime has failed to move with the times, disproportionately benefiting those who do conform to the so-called nuclear family structure, without giving adequate consideration to a myriad of equally relevant life circumstances. That being the case, the importance of undertaking proper tax planning on the basis of sound advice cannot be overstated, regardless of age and stage in life. 

How does the Inheritance Tax regime benefit traditional family structures?

Under the UK IHT regime, upon death each individual is entitled to a £325,000 tax-free threshold (known as the nil rate band). In basic terms, this means that for a single person with no children, they will only pay IHT if their estate exceeds £325,000. In that scenario, everything over the threshold is taxed at 40%. 

For a married couple without children, upon death of the first spouse, anything left to the surviving spouse passes to them tax-free. This means that, in many cases, the nil rate band of the predeceasing spouse will remain unused within their own estate. However, that tax-free allowance may be transferred to the estate of the surviving spouse upon their death (known as the transferable nil rate band). This means that a married couple benefits from a total tax-free limit of £650,000, beyond which tax is paid at 40%. 

There is an obvious logic to the status quo in this scenario - many people view the wealth developed over the course of a marriage to be shared, and they therefore don’t perceive assets passing to a spouse as an ‘inheritance’ as such. It would also clearly be unpalatable for a grieving spouse to have to sacrifice their established quality of life for the purpose of meeting an IHT liability. That being accepted, it seems only appropriate that the surviving spouse should benefit from an enhanced tax-free allowance, as their own estate will be enlarged by receiving their spouse’s assets. 

For a married couple with children, the above remains true. However, there is an additional tax-free allowance of £175,000 available to those who leave their home to their children, known as the residence nil rate band. Again, this is transferable between spouses, meaning that a married couple with children stands to benefit from a tax-free allowance of up to £1 million in respect of their combined estate. Again, there is a clear logic to this exemption in that many feel very strongly about leaving property to children and would not favour a child being forced to sell a property to meet an IHT liability. 

Nonetheless, the direction of societal travel is posing significant questions for the current IHT regime. Marriage is no longer the only way in which one might build up a shared life with another, so should more recognition be given to the shared wealth that cohabitants or others may enjoy? Indeed, one might also wonder whether children are the only beneficiaries of heritable property worth shielding from IHT. 

What can I do to mitigate my own liability?

The crux of the issue is that there are fewer tax reliefs available for unmarried people, and for those without children. Nonetheless, there are many strategies available for those who believe they will be in that position in the long-term, and who wish to mitigate their potential exposure to IHT. Examples might include making significant gifts to those with whom an individual wishes ultimately to share their wealth at an appropriate time, or making smaller, more regular gifts out of excess income on an ongoing basis. Legacies left to charity are IHT exempt, and leaving a significant enough portion of an estate to charity will reduce the overall rate of IHT payable. 

The appropriate strategy for each individual will, of course, depend on a plethora of considerations. Just like the modern family, there is no one-size-fits-all approach to tax planning. Shepherd and Wedderburn’s private wealth and tax team is well versed in assisting clients to identify and achieve their long-term goals, ensuring that their estate is maximised for their nearest and dearest, whoever that may be. 

For more information please contact Justine McCluskey, a solicitor in our private wealth and tax team, at Justine.McCluskey@shepwedd.com.

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