Inheritance tax: Turning a dream into hard cash

published 16 December 2014

Look at George Osborne and John Major and you might think they are as different "as chalk and cheese", says Ian Cowie in The Sunday Times. But they have one clear thing in common. They want, as Major put it back in 1991, to see wealth cascade down the generations. Major wasn't able to do much about inheritance tax back during his term in office it was politically impossible at the time. But Osborne has come up with some clever ways seriously to hobble it, even if we're not sure we approve of all of them.

First, he had already promised tax-free inheritability of defined-contribution pensions: from next April, if you die before you are 75, your pension passes 100% tax free to your heirs. If you are over 75, they will only pay income taxat their marginal rate on withdrawals.

In his Autumn Statement he added joint and guaranteed annuities to the list oftax-free inheritable pensions.

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This is all interesting in many ways, but the key to understanding the impact is recognising that pensions are just turbo-charged tax-efficient wrappers. If you are able to inherit not just the cash but the wrapper itself, you can grow the money inside free of income and capital gains tax indefinitely. This is an amazing perk that offers new opportunities for shrewd tax planning.But that's not all that's changed. More recently, Osborne announced that with effect from next April spouses will be able to inherit individual savings accounts (Isas) without losing their tax-free status too. At first glance this looks like it'll make no difference to inheritance tax since we don't pay inheritance taxon assets inherited from our spouses anyway but it still represents a major change.

Until now, Isa wrappers have died with their owners, so anyone inheriting their contents must pay income tax on it from the moment of death, and potentially capital gains tax as well. Now, assuming you have £1m in an Isa producing an income of £40,000, you could save upto £16,000 in income tax a year bybeing able to keep the wrapper, saysNeil Messenger of Grant Thornton.

So while this move doesn't actually cut your inheritance taxbill, it certainly cuts the overall tax you pay as a result of inheriting.That's good news. It also looks to us a bit like a statement of intent. The principle that tax-free wrappers in which most non-housing wealth is tied up in the UK can be transferred to heirs tax free has now been firmly established by Osborne. Given that, how long might it be before he announces that all Isa wealth can now be inherited inside its wrapper?

Even if the assets inside were taxed for inheritance taxpurposes, being able to keep the income and capital gains tax-free status of an Isa for the remainder left after inheritance taxis deducted would still be a major inheritance benefit for the heirs of the well-off and prudent. Something to watch. As Cowie says, Osborne clearly wants to turn Major's dream "into hard cash".

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.