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Death tax double-whammy: how the Government profits from your tax breaks

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A disaster for taxpayers, a bonanza for the Treasury Credit: Mark Magnaye for the telegraph

The Government is “having its cake and eating it too”, experts say, thanks to “disastrous” policies that were designed to reduce inheritance tax bills but have instead generated hundreds of millions more than expected for the Exchequer.

In 2015 the Government announced new pension rules for the highest earners, reducing the amount they could save into their pensions tax-free each year to just £10,000 with a “tapered allowance”. Breaching this limit can result in immediate tax penalties of up to 45pc.

The Government calculated that this change would generate £260m in the first year – money it would use to fund the new “family home allowance”, which would give families greater protection from inheritance tax (IHT).

It ended up making more than twice that amount – £615m. Pension breaches recorded by people who filed their own tax returns more than tripled in the same year, surging to £517 from £143 the year before.

Despite this additional revenue, and the extra tax relief on passing on a home after death, IHT receipts have continued to soar, increasing year-on-year since the family home allowance was introduced in 2017. The taxman now takes in more from death duties than ever before – £5.4bn in 2018-19 alone. It expects its annual haul to reach £7bn by 2023.

Rachael Griffin of wealth adviser Quilter said both policies had failed and the Government was “having its cake and eating it too”.

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She added: “The combined policies were supposed to be tax neutral. However, somewhere along the line the assumptions went awry and the scenario has in fact been disastrous for the public and beneficial for the Exchequer.

“These rules were supposed to help homeowners burdened with the threat of IHT while maintaining pension savings incentives for all but the highest earners – a double-edged sword that penalised pension savings for the rich while offering a quid pro quo for homeowners. That is not what has transpired.”

The family home allowance gives individuals who pass on their homes to direct descendants additional protection from IHT. This tax break started at £100,000 in 2017 but is increasing each year its ultimate level of £175,000 by 2020. This is on top of the £325,000 “nil-rate band” that each person is already entitled to.

The Government claimed that the changes would halve the number of estates paying IHT by 2020-21, saving taxpayers £725m. However, while the number of estates paying IHT fell in 2017-18 to 21,000 from 25,000 the year before, in the last tax year the number of estates falling foul of the taxman in fact rose by around 1,000, provisional figures show. The number of estates paying the death tax would have to drop dramatically in the next two years for the Government’s predictions to become reality.

What’s more, the new limits on pension savings have had unforeseen side effects that threaten to plunge the NHS into crisis. This is because a perverse quirk in the rules and the complex way in which defined benefit pension contributions are calculated mean doctors who work extra shifts or receive awards that boost their pay inadvertently funnel more into their pensions. This can trigger tax penalties that exceed annual salaries. Senior health professionals have said they are effectively paying to go to work.

As previously reported by Telegraph Money, amid rising waiting lists for procedures such as breast cancer screening and hip operations, doctors are refusing shifts to avoid the charges. As many as one in 10 have said they will quit if the rules are not changed.

Ms Griffin said: “Things have taken a strange turn if pension tax allowances can reduce the number of NHS professionals and risk the health of the nation.

“The rules of both these pieces of legislation have layers and layers of complexity. This means people are paying for the pleasure of navigating a tax system that counters common sense at every turn.”

A Treasury spokesman said: “We recognise that individuals work hard to build up their assets with the aim of passing them on to their direct descendants.

“We also want people to save into a pension, which is why we allow the majority of savers to make contributions tax-free. The annual allowance only starts to taper for high earners with a total income over £150,000 a year.”

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