How to mitigate inheritance tax

Inheritance Tax (IHT) is a tax on the estate (the property, money and possessions) of someone who’s died[1]. There are certain IHT implications when estates of a set value are passed on and there are options that should be considered when it comes to reducing IHT too; all of which should be factored into your financial planning.

We come across a lot of clients who are looking for the best possible way to reduce IHT to ensure that the benefactors, who are usually their children, experience the minimum tax implications when an estate is passed down. As the value of an estate determines the amount of IHT you’ll have to pay, it’s essential to note these figures:

  • For estates worth less than £325k, or those being left to a spouse or civil partner, then there are no tax implications.
  • It’s also key to note that this figure can be combined for married couples meaning that they’re exempt from paying IHT on an estate worth up to £650k.
  • Estates valued over £650k will be subject to tax at 40%.
  • IHT is also sometimes payable on trusts or gifts made during someone’s lifetime.

There will be a phasing in of an additional Residence Nil Rate Band (RNRB) from 6th April 2017, which can be offset against the value of your main residence. The RNRB is in addition to the standard NRB and will commence at £100,000 and rise annually by £25,000 until 6th April 2020. Thereafter it will rise in line with Consumer Price Index (CPI). However, the RNRB is reduced at a rate of £1 for every £2 for estates that exceed £2m. This threshold will also rise by CPI from 6th April 2021. As with the standard NRB, any unused allowance on first death will be used to uplift the survivor’s RNRB.

There are certain transfers that are exempt from IHT – broadly these are:

  • Transfers to a UK domiciled spouse.
  • Transfers to charities.
  • Transfers to political parties.
  • Lifetime transfers to an individual or an absolute trust after which the transferor lives for at least seven years and contain no reservation of benefit by the donor are known as “Potentially Exempt Transfers”.
  • If such transfers are survived by less than seven years, but more than three years, taper relief may apply. Taper relief reductions work as follows:
Years transfer survived by 3-4 4-5 5-6 6-7 7+
Percentage of tax payable 80% 60% 40% 20% 0%
  • Lifetime transfers out of income which do not reduce capital (i.e. one does not have to resort to capital to supplement diminished income).
  • The first £3,000 of a lifetime transfer in any tax year is exempt. This exemption can be carried forward for one tax year if unused.
  • Lifetime gifts to any person that do not exceed £250 in a tax year.
  • Lifetime gifts in consideration of marriage – the exempt amounts are £5,000 from parents, £2,500 from grandparents and £1,000 from others.

In addition Business Property Relief and Agricultural Property Relief may allow business persons and farmers to make IHT-free gifts of some of their business interests.

A simple life assurance policy could also assist in minimising any potential future IHT liability. A whole of life policy can be effected in trust to pay a potentially exempt sum to the beneficiaries of your estate to meet the Inheritance Tax liability. The premium can be claimed against the £3,000 annual exemption or normal expenditure out of income.

There are also investment schemes that can be put in place to help with IHT planning:

  • Enterprise Investment Schemes are a series of tax relief schemes designed to encourage investments in small companies. The structure of these investments can be beneficial as two years after the death of a person it falls out of their estate for IHT purposes.
  • Alternative Investment Market (AIM) portfolios also allow the value of the asset to fall outside of an individual’s estate for IHT purposes, after two years.
  • Another investment scheme that we focus on is an Enterprise Investment Scheme (EIS) which works in a similar way to AIM in that it will fall outside of your estate if held for two years. However, there are other significant tax advantages i.e. Income Tax relief, and these are great for high net worth clients.

When we work with our clients, we advise them on the IHT plan that is going to best suit their financial situation, taking all their assets into consideration. We also refer a lot of our clients to solicitors to prepare Wills and Trusts as this is essential when IHT planning to ensure an individual’s estate is going to the right people.

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