Downsizing is one answer to inheritance tax freeze

Soon after the Chancellor, Rishi Sunak, sat down after delivering his Budget speech last week it did look, for a moment at least, as if he really had come across a magic money tree.

Despite government debt reaching levels unprecedented in 300 years as a result of the covid pandemic, Mr Sunak managed to keep income tax and VAT at their current rates, while also delivering a temporary cut on the latter for the hospitality industry. Even the swingeing rise in corporation tax, from 19 per cent to 25pc, won’t become effective until 2026 and once in place will be payable only on profits about £250,000, thus bringing a great sigh of relief to many SME’s.

Less welcome was the announcement that income tax thresholds will be frozen, which will make anyone on PAYE who receives a wage or salary rise become liable to pay more.

Another freeze will have been on the mind of many who have left work behind – Britain’s growing army of retirees, especially the ones who might be described as “comfortably off”. I refer to inheritance tax (IHT), the threshold (or nil rate band) of which will remain at £325,000 until at least 2026.

Until 2009 both Conservative and Labour governments annually raised the nil rate band but this stopped following the financial crisis and it has remained static ever since, during which time thousands of additional estates have become liable largely, though not solely, because of soaring residential property values. True, the threshold doubles for married couples and can even go as high as £1million if a home is involved but it still exposes many in the “villa belts” to IHT, which is levied at 40pc on anything above the threshold. Also, divorce has led to many increasing numbers of people finding themselves single again in later life, thus exposing their assets to the £325,000 threshold.

It would seem, therefore, that this new four-year freeze heightens the case for older homeowners to downsize, where appropriate. Downsizing is not always related to finance but the IHT situation may be another good reason for raising capital that usually results from moving from a larger property to a smaller one.

IHT is not, of course, a tax on an individual with assets but on those who benefit from his or her estate. One legal way of avoiding this is to give away money to adult offspring (or anyone else for that matter) while alive and (preferably) still in good health. Should the giver survive for seven years there is no tax to pay on the “gift” and even then it starts to reduce gradually meaning that if the giver does die during that period the tax payable may be less than 40pc.

However this option becomes less likely if too much of a person’s assets is tied up in his or her main home.

I am not saying that people should downsize simply to try and reduce IHT liability but for those with larger properties it seems wise to consider this as part of a wider lifestyle/financial strategy – which of course might include raising money to spend enjoying oneself as well as on close family members!

Meanwhile there may actually be relief in many quarters over the Chancellor’s decision to freeze the threshold on capital gains tax (CGT). Yes, this effectively is another “tax increase by stealth” but as recently as November some Treasury gurus were proposing swingeing cuts to the threshold – from the current £12,300 to as low as £2,000. So, in the circumstance, it’s a less-worse outcome than might have been feared by property investors and second-homeowners.

David Alexander is managing director of DJ Alexander