Inheritance tax often seems to be Britain’s most hated tax, a reputation that may be a little harsh given that it is paid by less than 5% of estates each year.
For those who are affected by inheritance tax (IHT) it is a serious issue as of course we would all like to leave as much as possible to the next generation.
Planning is essential. Before you can consider how to reduce your exposure to IHT it’s important to assess whether your estate is likely to be subject to IHT at all, and if so, how much.
Here’s some ideas as to how you might be able to reduce your IHT liability:
Use your annual allowance
Everyone can make gifts of £3,000 each year with no IHT consequence. This may not sound much in the grand scheme of things, but if you can start early and gift £3,000 each year for 30 years this would ultimately save your estate £36,000 – more if you consider the effect of inflation – so it’s worth thinking about.
Use the small gifts exemption
You can make any number of gifts of less than £250 each which again, might not sound much, but if you have a number of children and/or grandchildren and make gifts over a number of years then a significant saving can build up.
You can only use one of these allowances or exemptions per individual – so if you have already gifted £3,000 to somebody using your annual allowance, you can’t gift them a further £250 in the same year using the small gifts exemption.
Use the normal expenditure out of income exemption
If done properly, quite significant amounts can be passed on without IHT consequence using this exemption.
If you have more income than you need each year to maintain your required standard of living, then you can pass on this income by making regular gifts.
You need to determine your required income, identify the excess, and establish a pattern of gifting.
Make larger lifetime gifts
Every seven years you can benefit from a new nil-rate band of £325,000 – if you survive seven years after making a gift it falls out of your IHT estate, so it is definitely worth considering making those larger gifts during your lifetime.
If you don’t survive the seven years then the nil-rate band would be applied to the value you gifted first, before the balance of your estate.
It could be worth considering gifting assets that are likely to increase significantly in value within a short period of time – better to risk an IHT liability gifting an asset worth £50,000 than have it sitting in your estate a few years later having risen in value to £150,000.
You do need to think about capital gains tax when gifting assets.
Invest in IHT friendly assets
Unquoted shares can qualify for 100% Business Property Relief so they can be passed on during lifetime or on death IHT free.
This would include shares traded on the Alternative Investment Market (AIM) and shares in family companies.
There are a number of conditions to be met, including a requirement that the company be trading, and the shares must be held for two years in order to qualify for the relief.
Leave assets to charity
Money or assets which are given to charity are not subject to IHT, during lifetime or on death.
If you leave 10% of your estate to charity, the balance of your estate benefits from a reduction in the IHT charged, from 40% to 36%.
Take out life insurance
Once you have quantified your likely IHT liability you could consider taking out a life assurance policy to cover some or all of this liability when the time comes. This doesn’t reduce that liability but it could provide peace of mind that the cost is covered.
Make sure that the policy is written into trust so that the payout is outside your estate. This is true of all life assurance policies – make sure they are written into trust so the payout is not made into your estate and subject to IHT.
Give assets to trusts
If you would like to pass on assets to the next generation during your lifetime but are worried about losing control of those assets and watching them being frittered away or lost from the family in the event of separation or divorce, consider using a trust.
Assets can be held in trust so that they are no longer in your estate for IHT but you can be a trustee and retain control over what happens to those assets. Trusts can also be used to provide an income for beneficiaries and a capital sum if the trustees agree.
Trusts can also be written into your will so that assets pass into trust on death.
Review your pensions
The Pensions Freedoms Act 2015 gave us much more choice about what to do with our pensions during our lifetime, but these choices do have IHT consequences.
It is possible to pass on your entire pension pot IHT free, but only if the required conditions are met, so when reviewing your pension options, always consider the impact on a future IHT liability.
Use the residence nil-rate band
This relief was introduced fairly recently and adds an extra £150,000 to your nil rate band from April 2019 and £175,000 from April 2020 for you to use against the value of your residence, provided that this is left to a direct descendant.
If you have downsized you can apply the nil-rate band to the surplus funds generated from the sale.
The additional nil-rate band can also be transferred from a deceased spouse to the surviving spouse if it is not used on the first death.
Use a Deed of Variation
No matter how meticulously you plan, there is always the chance that something unforeseen happens that means your will is not as tax efficient as it might be.
Following a death, the executors and beneficiaries of the will have two years to make a Deed of Variation to vary the terms of the will.
Again there are various conditions to be met and consequences for income tax and capital gains tax as well as IHT.
Make a Will
Yes, I know this is number twelve, but it is really important.
If you die intestate, then the law will decide who inherits your assets.
You will also have no executors so the process of obtaining probate and distributing assets is made more complicated and can take much longer.
Please make a will!
For more information about any of the above points, or to request an IHT review, please contact me.
