It is estimated that Inheritance Tax (IHT) will raise around £7.2 billion for the Treasury in 2023/2024. This has roughly tripled in the last 10 years, and the Office for Budget Responsibility (OBR) states that actual receipts have consistently been higher than their predictions.
So why has IHT risen so dramatically in recent years?
Firstly, the nil rate band has been frozen for over a decade rather than increasing with inflation. This means that more of a person’s estate will be taxed in real terms.
Secondly, wealth and property prices have increased at a rate higher than inflation, which means that estates are generally worth more. The Residence Nil Rate Band (RNRB) has gone some way towards mitigating this, but only applies in certain situations.
Below, we explain how IHT works and some options to help you pass on more money to your loved ones.
How Does Inheritance Tax Work?
When someone dies, their estate is measured against the nil rate band. If the estate is valued at over £325,000, the excess is taxed at a rate of 40%.
Any assets passed to a spouse are not immediately chargeable, and your spouse will inherit any unused portion of your nil rate band. This means that on second death, the surviving spouse may have a nil rate band of up to £650,000.
Additionally, if a main residence is included within the estate, the RNRB may also apply. This provides an additional nil rate band of up to £175,000 per individual (£350,000 for a couple), capped at the value of the property. The RNRB can only be claimed if the property is passing to a direct descendant. It is also tapered away if the estate is valued at over £2 million, you can work out the impact of the taper here.
With careful planning, there are a few options available to reduce IHT and ensure that more of your wealth passes to those you intended.
The Importance of Writing Your Will
Regardless of your IHT position, it’s a good idea to have a valid, up to date Will in place. This allows you to appoint someone to administer your estate, as well as your beneficiaries. If you don’t have a will, the rules of intestacy will apply. These rules are highly inflexible and may not meet your wishes (you can find our what would happen to your assets without a will here).
Some ways in which your will can help to reduce IHT include:
- You can direct money or assets into a trust. This will still use your nil rate band (and potentially incur IHT), but it avoids increasing the estate of the beneficiary. The trustees can then manage the assets to suit the beneficiaries’ circumstances.
- You can decide how much to pass to your spouse or other beneficiaries depending on your situation and nil rate band. For example, if you have inherited a nil rate band from a previous marriage and have since remarried, it might make sense to leave some assets to other beneficiaries (e.g. your children) to fully benefit.
- If you leave at least 10% of your estate to charity, not only will this not incur IHT, but your residual estate will be taxed at 36% rather than 40%.
Creating a will is usually simple and generally inexpensive, so it’s a good idea to do this as soon as possible.
Using Gifting Allowances
You can gift up to £3,000 per year, which is immediately outside your estate. You can carry this forward by up to one tax year. Alternatively, you can make unlimited gifts of £250 to multiple people.
You can also make regular gifts from surplus income. There is no limit to the amount, but it must form a regular pattern and be affordable without the need to draw on your capital.
A full list of gifting exemptions is available here.
Any gifts which do not qualify for exemptions will drop out of your estate after seven years. If you do not survive for seven years the gifts will be brought back in full into your estate for the first three complete years before being tapered by 20% for each full year (falling to 100% relief at the 7th year). See the example below.
|Number of years before death
|Taper Relief %
|Tax Payable on Gifts Above Nil-Band Rate
Making lifetime gifts can help to reduce the value of your estate as well as passing wealth to your loved ones when they need it most.
If you have a substantial estate and are comfortable giving up access to some of your money, a trust may offer a solution. Not only can this help to save IHT, it can also protect family wealth against bankruptcy, divorce, or financial mismanagement. Most gifts into trust drop out of your estate after seven years.
There are various types of trust, which vary in terms of tax treatment, complexity, and flexibility.
Discretionary trusts are commonly used for IHT planning as this allows trustees to decide which beneficiaries should receive trust assets and when. However, discretionary trusts can incur IHT charges on entry, exit, and at 10-yearly intervals if the value is over the nil rate band.
Loan trusts and discounted gift trusts can also be suitable if you wish to retain access to some income or capital.
You can find out more about different types of trust here, however trust planning is a complex area where making mistakes can be very expensive and it’s worth taking professional advice.
If you have an IHT liability, a simple way to address this is to set up a whole of life insurance policy. If this is placed in a suitable trust, it will bypass your estate and avoid an possible IHT charge. These plans are only going to be available as an option if your health is still good enough or it is affordable to qualify for a life insurance policy.
This can provide beneficiaries with a lump sum to pay the tax. Alternatively, if you think you will need your assets later in life (e.g. to pay for care), an insurance policy can ensure they will receive a certain amount regardless of how much is left in your estate.
Another option is to invest in the shares of small companies. By using the right type of investment vehicle, you may be able to save on IHT, as well as income tax and capital gains tax (CGT).
The main options are:
- Enterprise Investment Schemes (EIS) – this provides IHT, income and CGT relief.
- Alternative Investment Market (AIM) shares – this offers IHT relief only, but can be held in an ISA to reduce other taxes.
- Unlisted business relief solutions or estate planning products – these offer IHT relief only.
The main advantage is that these investments can qualify for relief after two years rather than seven. However, they are generally very high risk so are not appropriate for everyone as you could potentially lose all of your money invested. .
Why it’s Essential to Plan Ahead
When you undertake IHT planning, it’s important to balance priorities, for example:
- Tax efficiency.
- Flexibility over who can benefit.
- Whether you need access to the money yourself.
Giving away too much too soon can create problems later on. By starting early, you can make slow and steady progress without depriving yourself of money you may need. A financial planner can help you create an estate plan that works for you.
Please don’t hesitate to contact a member of the team to find out more about estate planning.
We offer an Estate Planning service and carry legal professional indemnity for Wills, Trusts and Powers of Attorney. The Financial Conduct Authority does not regulate tax and estate planning, wills or trusts.
Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor
The content in this article was correct on 03/10/2023.
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