Recognised as the least popular tax in a YouGov poll a few years ago, Inheritance Tax (IHT), in reality, remains largely avoidable with some forethought and planning. But, what exactly is it?
IHT is, potentially, a 40% tax on a portion of your estate when you die. A typical estate might comprise of cash, vehicles, a second property, investments, watches and jewellery.
There are two allowances, up until which the value of your estate is exempt from IHT;
- The Nil-Rate Band (NRB) which is currently £325,000
- The Residence Nil-Rate Band (RNRB) currently £125,000 rising £25,000 a year to a maximum £175,000 in 2020/21. The RNRB provides an additional allowance to help to pass the family home to your children.
So, the total current IHT allowance per person is £450,000, rising to £475,000 in April this year. As transfers between married or civil partnership couples are exempt, their total allowance is consequently £900,000 rising to £950,000 in 2019/20.
Other than simply spending your wealth during your lifetime, there are a number of ways you can reduce or eliminate completely your potential IHT liability. They include, but are not limited to:
- Ensuring you have a valid, up-to-date will. Surprising, 60% of UK adults don’t; that’s a staggering 31 million people according to statistics from Unbiased. Dying without one means you die under the rules of Intestate and have no control over who in your family receives your estate and in what proportion. Significantly, this is likely to create an entirely avoidable IHT bill if your estate exceeds the allowances. If you do have a will, it’s worth regularly checking to make sure it’s up to date and still relevant.
- Making small gifts and ‘gifting from excess income’. Any gift you make, no matter the value, is exempt from IHT if you don’t die for seven years after making it. If you do, there is a sliding scale as to how much tax your estate would be liable for.
Exempted gifts, no matter of timescale, are up to a maximum of £3,000 each tax year. This is known as your annual exemption. You’re also able to gift £1,000 per person as a wedding or civil ceremony gift, or as much as £5,000 if it’s your child getting married.
Making gifts out of income is an unlimited IHT exemption in time and value. But, to qualify the gift must form part of your normal expenditure, be made from your regular income and cannot reduce your standard of living.
- Using Trusts. Trusts can be quite complex, but it’s possible to pass the ownership of an asset, such as an investment or property by placing them in trust. They are then considered outside of your estate. In some circumstances, you can still benefit from the asset, by taking a fixed income, for example. There are a number of different types, which is most appropriate, will depend on your circumstances.
Not all trusts are exempt from IHT and some are subject to their own Inheritance Tax regimes. There may also be Income and Capital Gains Tax considerations; if you’d like to discuss trusts in detail, please get in touch.
- Making charitable donations. All charitable gifts are tax-free and if you are a higher or additional rate taxpayer, you could reclaim Income Tax via Gift Aid. But, if you include a charity donation in your will, it won’t be considered for IHT. More significantly, if you leave 10% or more of your estate’s value to a charity, it actually reduces the rate of IHT you are potentially liable for, from 40% to 36%.
- Exploiting Business Relief. Originally intended to stop family-run businesses being sold when the owner died, Business Relief enables you to pass on a business, its assets, or an interest in a business exempt, or at a reduced rate, of IHT. You must have owned the asset for at least two years for it to qualify.
Certain Shares in unlisted companies (i.e. Not traded on a formal stock exchange) are 100% exempt from IHT under Business Relief provided they are held for more than two years. Importantly, shares on the Alternative Investment Market (AIM) qualify as unlisted, and there are numerous AIM investment portfolios available. Some can also be held in an ISA, meaning they’re free from Income and Capital Gains Tax, too. AIM portfolios can be higher risk; if you’d like to explore this option please speak to us.
- Make more pension contributions. The tax-efficient Annual Allowance for paying into your pension is a maximum of £40,000 a year (or £3,600 if you have no net relevant earnings), and the Lifetime Allowance (the maximum tax-efficient value your pension can be) is currently £1.03 million. Often, most pensions are exempt from IHT if you nominate a beneficiary to receive its value when you die. By making the most of your eligible tax-efficient allowances you can minimise IHT at the same time as providing an income in retirement.
If you’ve exhausted your options to completely avoid an IHT liability, you can insure against the likely tax bill. It’s important that the policy provides an appropriate sum upon death, but more significant is the need for it to be written in Trust. That means having a named beneficiary to receive the lump sum when you die. If it is not in Trust, its value would be added to your estate, increasing the potential IHT liability.
If you would like to discuss your potential IHT liability and how you can leave the most of your legacy to loved ones, please do get in touch. Everything we offer is tailored precisely to you, your family and your financial aspirations.
The Financial Conduct Authority does not regulate Wills, Tax advice or Trust advice. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances. The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.