George Osborne And The Three Bears

Here’s a mildly frivolous look at what the new inheritance tax rules will mean.

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Momma Bear and Poppa Bear live in a 1-bed cottage in the middle of the forest. They have one child, Baby Bear, who stands to inherit their entire estate which along with the cottage also includes a substantial investment on the porridge futures market, and the family business: a home security firm the Bears set up following a break-in some years ago.

Under current IHT rules both Momma Bear and Poppa Bear can each pass on £325,000 before inheritance tax kicks in – so Baby Bear could inherit £650,000 tax-free.

With the new regime the Bear parents each get an extra £175,000 “family home allowance”, giving a total allowance per Bear of £500,000 – a potential combined total of £1m for Baby Bear to inherit tax-free BUT with £350,000 of it (the £175k per parent) ringfenced for the family home.

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So, let us assume the cottage is worth £300,000, the business £175,000 and their investments £75,000. That means the total estate is worth £525,000 which would fall within the current limits (£325,000 per parent) and would be unaffected by the change.

This is too little.

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Or, let’s suppose the cottage is still worth £300,000, but the family business is more successful and valued £600,000, and they’ve got a cool quarter of a million riding on porridge futures. That would make the whole estate worth £1.15m. Under the current rules Baby Bear can only have £650,000 tax-free so ends up paying 40% inheritance tax on the extra £500,000.

In theory the new rules allow Baby Bear to inherit up to £1m tax free, so would only pay IHT on the last £150,000. BUT remember that caveat: £350,000 of it is ringfenced for the family home; with the cottage worth £300,000 that falls within the home ringfence but doesn’t get the full benefit. The other assets, combined valued £850,000, are tested against the standard £650,000 allowance so Baby Bear ends up paying inheritance tax on the £200,000 difference.

This, for the sake of narrative tension, is too much.

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If, however, we say the cottage is worth £500,000, the porridge investment £200,000 and the family firm £300,000, that would put the full estate value at a remarkably convenient £1million.

The current IHT regime would leave Baby Bear liable for tax on £350,000, but the new rules mean Baby would get the full benefit of the family home allowance while the rest of the estate falls within the standard £650,000 limit – so on the new rules Baby Bear pays no inheritance tax at all.

And that, as far as Baby Bear is concerned, is just right.

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