I was contacted by a potential client who had recently lost their father they received a sizeable inheritance and wanted to ensure they minimised their inheritance tax bill. They wanted some advice on how to use the money to secure their financial future.
As part of the financial planning process, I gather information on their current circumstances, and they sent me a copy of the IHT400. This is the document that the executors of a will complete to calculate the value of the deceased estate and the amount of inheritance tax due. In this case, the amount payable to Her Majesties Revenue and Customs was a not insignificant £250,000. A good financial planner would have been able to significantly reduce that amount, but in case you don’t have one I wanted to share some tips on ways you can mitigate the amount of inheritance tax payable on death.
What is inheritance tax?
Inheritance tax (IHT) is paid by the executors of the estate of a deceased individual and in certain circumstances when you give away assets or money.
How much is it?
The current rate of inheritance tax in the UK is 40% of the value of your estate above any nil rate allowances available. At the time of writing the current (2020/21) nil rate band (NRB) for IHT is £325,000, which means the first £325,000 does not attract IHT. In 2017 the government introduced the resident’s nil rate band (RNRB). This increases the NRB by £175,000 taking the total nil rate allowance to £500,000, provided a residential property is left to a direct descendant, however, it does come with some conditions attached.
The deceased need to have owned a property and it must have been their main residence at some point during their ownership.
If the value of the estate is in excess of £2 million the RNRB will be gradually reduced by £1 for every £2 that the value of the estate exceeds £2 million.
The property must pass to direct descendants, children, grandchildren, including stepchildren, foster or adopted. It does not include nieces, nephews, or brothers and sisters.
A word of warning, if you use a will trust and the qualifying residential property goes into a discretionary trust on death you will lose the RNRB, however, if the property is distributed to a direct descendant within 2 years the RNRB could potentially be reclaimed.
How to reduce your IHT?
Use your allowances
If you have surplus savings and assets which you are never going to need, consider giving some away. You can give away up to £3,000 a year which would not form part of your estate on death. You can carry any unused allowance forward to the next year, but only for one year. You can also give gifts for weddings and civil partnerships, £1,000 per person £2,500 for a grandchild and £5,000 for a child. Finally, if you have any surplus income you can gift it away provided you can maintain your usual standard of living.
Make Gifts
You can also make larger gifts, these can be directly or if you prefer to retain some control over the money, via a trust. Provide that you survive 7 years from making the gift it will fall outside of your estate.
Trusts are a separate vessel which allows you to gift money away as the settlor and by appointing trustees to retain control of how the assets are invested and distributed. Taxation of trusts is a complex area and you should seek specialist advice before considering setting one up.
Consider Life Assurance
Although it is not technically a way to reduce the level of IHT you pay, it is a way to ensure the executors of your will are not forced to sell assets to pay the bill. In the case of the client, I have mentioned above that would have involved taking out a Whole of Life Insurance policy written in trust for a sum assured of £250,000. This would have paid out on the life assured’s death and enabled the executors to pay the IHT due.
Make a Will
One of the simplest ways of managing your inheritance tax is making a will. It allows you to choose how your assets are distributed on death, meaning you can plan and therefore minimise your IHT. If you do not have a valid will in place your estate is distributed under the rules of Intestacy, which is unlikely to be the most tax-efficient solution.
Use Business Relief
To qualify for business relief the deceased must have owned the qualifying assets for at least 2 years and still own them at the time of death. Business relief can be claimed on several assets
Business property @ 50% relief
Unlisted shares @ 100% relief which includes Enterprise
Investment Schemes (EIS), and shares listed on the alternative investment market (AIM)
Machinery @ 50% relief
Shares controlling more than 50% of the voting rights in a listed company @ 50% relief.
These investments are generally high-risk and should only ever be considered by people with the necessary knowledge and experience of investing.
Pensions
Under current legislation, most pensions fall outside the member’s estate on death, which makes them an excellent IHT planning tool because so many people already have one. You can continue to make tax relievable contributions into a pension until aged 75, so in addition to reducing your IHT bill, you’ll benefit from tax relief on contributions to the maximum of £40,000, your earned income or £2,880. Your £2,880 would benefit from an additional £720 in tax-relief and potentially save a further £1,440 in inheritance tax on death. If you have accessed your pension, then the maximum could be reduced to £4,000 per year.
Summary
As with most things related to tax, they can be complex to the average person. At 4 Financial Planning we offer a free inheritance tax review. If you would like to see if we can save YOU any money please book in a free consultation https://calendly.com/ian4fp/discovery-meeting