Important information - the value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

TAXES on both capital gains and money passed on after death are high on the list of concerns of many investors - but which is likely to bite them hardest? 

New analysis by Fidelity has highlighted that, while Inheritance Tax (IHT) is the cause of much upset for families, it may be Capital Gains Tax (CGT) that represents the bigger downside risk. That’s certainly true at the aggregate level because - as our numbers show - CGT produces significantly higher revenues for the government than IHT - and the gap is widening.  

What’s more, there’s reason to think that changes to tax rules will result in CGT liabilities growing faster in the future, with significantly more assets being pulled into the scope of the tax. 

For a detailed breakdown of how each tax works, please see our guides to Capital Gains Tax and Inheritance Tax

IHT and CGT: Perception and reality 

Few taxes stir up negative feeling like Inheritance Tax. Besides the fact that it affects those who have lost someone close to them, IHT is perceived as being a double tax - which is to say a tax on money which may have already been reduced by tax once, perhaps as income or as a capital gain. The so-called ‘death tax’ is the subject of regular campaigning for its reform, or even removal altogether, despite the fact that relatively few people are affected by it (see below). 

Capital Gains Tax, by contrast, does not enjoy the same notoriety, perhaps because it is seen as a tax more explicitly aimed at the rich.  

Yet a simple comparison of the money raised by each tax reveals it is CGT that is most costly to taxpayers overall - and it’s not close. Using HM Revenue & Customs data you can see that CGT raised two-and-a-half times the money raised by IHT at the last count. In 2023/23, CGT pulled more than £18bn into the government’s coffers, versus just over £7bn from IHT.

None

Source: HMRC. IHT receipts taken from HMRC tax receipts and NI contributions for the UK, 21.7.23. CGT receipts taken from HMRC Capital Gain Tax statistics, 3.8.23.

The bulk of the gap between the two has opened up within the last decade or so. Rewind to 2012/13 and CGT raised just £3.8bn verses £3.1bn from IHT. 

A brief note on these figures - we have used the most up-to-date numbers available from HMRC. Data for both IHT and CGT receipts are updated on an ongoing basis and, because final tax bills may take several years to be settled, both figures are subject to revision in future years. 

Recent trends - and what happens next 

The growth in the amounts collected in IHT, and in the numbers paying the tax, is well-documented. In 2020/21 there were 27,000 taxpaying IHT estates, an increase of 17% since the previous tax year, 2019/20. The sum liable for IHT in that year was £5.76bn, up 16% compared to the previous year.1 

The £325,000 nil-rate band for IHT, within which no IHT applies, has been frozen since 2009/10 so rising asset prices - including for residential property - have had the effect of dragging more estates into range of the tax.  

There have been important changes over the years, however, which have limited IHT liabilities. Since 2008 the transferable nil-rate band has allowed unused nil-rate bands to be passed on to spouses and civil partners on death, giving estates much greater protection. Then the introduction of the full £175,000 residence nil rate band from 2017/18 - which applies if a primary residence is being passed on - has acted to limit IHT liabilities even further. 

On top of this, the current government is reportedly considering further changes to reduce - or even abolish - IHT.   

In the case of CGT both the total gains made, and the tax paid on them, hit new records in 2021/22. The total CGT liability was £16.7bn for 394,000 taxpayers on £92.4bn of gains. Both the total CGT liability and the amount of gains have increased by 15% from the previous year, while the number of taxpayers has increased by 20%.2 

The system for CGT has been getting less generous with the rates now set at 10% for basic-rate taxpayers and 20% for those paying the higher-rate and above. The rates jump to 18% and 28% respectively if a gain is made from disposing of a residential investment property. 

A capital gain can be made each year without CGT applying - the annual exempt amount - but this is reducing. Previously set at £12,000, it reduced to £6,000 this year and will drop further to £3,000 in 2024/25. The government estimates that this will raise an extra £440m a year in CGT from 2025.3 It is also likely to mean more people with lower levels of wealth will be pulled into the tax. 

But these may not be the end of the changes to CGT. Further reforms have been rumoured - but so far resisted - to equalise CGT rates with those of Income Tax, representing a significant tax rise on gains. 

Identifying the risk to you 

It is only the wealthiest individuals who are likely to be affected by either IHT or CGT. At the last count just 3.73% of deaths resulted in an IHT charge. Most CGT comes from a tiny number of taxpayers - in the 2021 to 2022 tax year 45% of CGT came from those who made gains of £5million or more. 

ISAs and pensions can provide valuable protection against these taxes. Gains inside both are free of CGT, while money held inside a pension will not fall within your estate for IHT purposes. Important exemptions and allowances also exist that can reduce your tax liability. These are explained more in our guides to Capital Gains Tax and Inheritance Tax.  

Fidelity’s financial advisers may also be able to identify whether either tax is an issue, and can help maximise the options available. 

Source:

  1. Gov.uk, Inheritance Tax statistics, 26 July 2023 
  2. Gov.uk, Capital Gain Tax commentary, 3 August 2023 
  3. Gov.uk, HM Treasury, Autumn Statement, November 2022 

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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