Did you know that HMRC has quoted there were inheritance tax receipts around £4.9billion in 2016/17?
Despite the Government’s changes to allowances, inheritance tax is still a concern for many people. However, with a little forward planning, there are ways to mitigate its effects - or perhaps remove the threat completely.
In this section, we outline the main allowances and how our advice might you help take advantage of any opportunities.
How can you shelter your estate from Inheritance Tax?
The cost of a large estate
Not everyone pays Inheritance Tax. However, if your estate is valued at more than the 'Nil Rate Band' (NRB), then your beneficiaries will be expected to pay 40% of the total value of assets in excess of that amount to the Government.
Currently set at £325,000 (per individual, or £650,000 for a married couple/civil partners) the NRB is a standard allowance which everyone is entitled to. Thanks to changes in legislation that become law in April 2017, there is also now an additional Residential Nil Rate band which can be used if you own a house.
Without a bit of forethought, therefore, an Inheritance Tax bill can lead to the quick sale of valued possessions, maybe including the family home. Beneficiaries might find they have to sacrifice beloved items at what will already be a distressing time – and in some cases, take a lower than market value offer to meet the six month deadline.
However, it only takes a bit of sensible planning to avoid such a situation. Depending on the size of the problem, there are a number of ways to reduce - and even if not completely remove the liability then at least make it possible to protect your main assets... particularly that house.
Qualifying for exemptions
Inheritance Tax (IHT) is the tax that becomes payable on your estate when you die.
However, as with any other tax, there are some exemptions that will reduce or may even remove your own estate from that requirement.
First things first...
What are you worth? To find out, you need to add together the values of virtually everything you own, including:
The value of your house and any other properties you own (minus any mortgage or equity release debt-liability these may carry)
Savings & investments, including ISA accounts
The value of payouts expected from life assurance policies
Any pictures, wine or other 'investments' you have made outside the normal range
Other assets and items of value you own, including your car and jewellery
Some pension funds are exempt from IHT. Please feel free to contact us if you have any questions about what does and does not qualify for exemption - and how you can use pensions as part of the IHT planning process.
Married couples & Civil Partners
Regardless of the value of your estate, you can pass everything over to your spouse or civil partner free of liability. This ensures that they can continue to live in the house and off the income and assets that you have accumulated with them over your time together.
There are two things to be aware of, however:
If you pass on some of your asserts to others at this point, they may still have to pay IHT.
This only applies to married couples and civil partners. If you are co-habiting, this allowance will not apply.
You should also be aware that this move does not exempt your estate from IHT completely. It simply defers the calculation on that element of your assets until after your spouse has also died. But more of that below.
Nil Rate Band
For all estates, there is an exemption called the Nil Rate Band (NRB). Currently set at £325,000, there is no IHT liability on this portion of your estate. And if your estate is valued at less than £325,000, no IHT will be payable at all.
Everyone gets their own Nil Rate Band. And if you are married, and do not use that NRB when you die, your spouse/civil partner will be able to inherit that from you - meaning that, in effect, married couples and civil partners have a combined NRB of £650,000.
If you are married or in a civil partnership, therefore, the fact that this NRB can be either used on death or passed on to your spouse on death opens up many options for planning - and potentially reducing the ultimate IHT liability on your beneficiaries.
Residential Nil Rate Band
Rising house prices have meant that for many people, the simple fact of owning a house has taken them into the realms of IHT. And when the house is the only asset that brings along such a liability, children have found themselves forced into selling the family home, at a difficult time, simply to meet the bill.
Since April 2017, therefore, it has also been possible to claim the Residential Nil Rate Band (RNRB) which is currently £175,000.
Again, everyone has their own RNRB if they meet the following criteria:
You own a residential property, ie: your own home
You want to pass htis home to your children or grandchildren (only)
Your total estate, including the property and all other assets, is worth less than £2million
If you are married or in a civil partnership then, as with the NRB above, the RNRB can be passed over to your spouse, increasing the value of that combined RNRB to £300,000.
However, as with all exemptions, there are three things you need to be aware of:
The RNRB is not available to you if you sold your home before April 2015, for example to move into long term care or to live with the children.
If you estate is valued above £2million, then the RNRB will be reduced by £1 for every £2 your estate exceeds that.
If your home is worth less than the RNRB, you can only claim exemption up to the value of your residential property.
In summary, if you’re married and your estate is worth less than the £2m threshold, any unused allowance can be added to your partner’s allowance when you die. This means their threshold can be as much as £1m.
However, if the net value of your estate exceeds £2m, the additional nil rate band will be reduced by £1 for every £2 by which the net value exceeds that amount.
The key to managing the IHT liability for your children is therefore to plan in advance. The rest of the pages in this section are dedicated to the most popular methods of doing so.
Annual exemptions & allowances
There is an annual exemption of £3,000 for gifts which those who wish to reduce the size of their estate can take advantage.
Any unused exemption in one year can be carried over to subsequent tax years, up to a maximum exemption of £6,000 in any one year. Certain smaller gifts for specific reasons are also exempt of Inheritance Tax and do not count towards this £3,000 total.
These include gifts for weddings of:
£5,000 for a child
£2,500 for a grandchild
£1,000 to anyone else
Gifts of up to £250 can also be given to individuals as long as the same person does not receive more than £250 in one tax year
and that person has not also received either a wedding gift or money that is counting towards the £3,000 annual exemption.
Gifts from regular income
There is no Inheritance Tax payable on gifts from regular income, after tax, as long as the giver is left with enough income to manage their normal lifestyle.
Gifts that can be given from regular income include:
Christmas, birthday and wedding, civil partnership or anniversary presents
Money paid in premiums on a life assurance policy
Regular payments made into a savings account
To confirm that the money being given from income is not having a detrimental effect on lifestyle, it is advisable to keep a gift log. This may be required by the executors of your estate to support any claim that is then made against your estate later.
This log should therefore be fairly comprehensive. You should list out the net income being received, by source, and against that, list details of your expenses before the gifts are made. Expenses should include all items, ie: not just large payments such as mortgages or rent but also insurances, household bills, holidays, entertainment, travel, care fees, etc. Using such a form would make it obvious to an observer how much surplus you have left and therefore what you can afford to fund items such as those listed above.
Payments to support living costs of another
The only other exempt payments are those used to support the living costs of other people. These include payments to:
Ex-husbands, ex-wives, former civil partners
A relative who is dependent on you because of age, disability or illness
A child (including adopted or step-child) who is still under 18 or still in full time education
You can make donations to charities during your lifetime without being liable for Inheritance Tax on the gift.
This exemption also covers donations to museums, universities and community amateur sports clubs.
In addition, if you leave a donation of at least 10% of your estate value to charity, the Inheritance Tax liability for your beneficiaries on death will be just 36% rather than the usual 40%.
Finally, there is no Inheritance Tax payable on donations to political parties, as long as the party concerned has either:
At least 2 members elected to the House of Commons or
1 member elected to the House of Commons but also received a total of at least 150,000 votes at the general election
Lifetime gifts & taper relief
Lifetime gifts can be a way of giving away assets during your life - if you can live without them
A lifetime gift includes money, property or possessions given away during your lifetime, or which were either sold or transferred for a value less than that asset was actually worth.
Hence, assuming gifts do not fall within the exempt gifts listed on this page, a potential Inheritance Tax (IHT) liability would arise in all the following examples:
You gave one of your children a gift of £25,000 to use as deposit to buy their own house in their own name;
You offered to pay off a £10,000 loan for a friend or relative without a putting into place a repayment agreement which would recoup your money;
You sold your house to your children at 50% of its market value.
The 7 year rule
In all of the above examples, however, the amount of the gift is only potentially liable to IHT.
Officially, lifetime gifts of this nature are referred to as Potentially Exempt Transfers (PETs). This is because, if, from the date of the lifetime gift, you survived at least another seven years, the gifts would then become exempt.
However, if the giver died within that seven year limit, the gift would be added back into the value of the estate on the following sliding scale. This scale is based on number of years death occurs since and percentage of value added back in:
0-3 years - 100%
3-4 years - 80%
4-5 years - 60%
5-6 years - 40%
6-7 years - 20%
7 years + - Zero
Assuming you can afford to run your life in the way you wish, therefore, giving away money or possessions during your lifetime is a valid way of reducing the eventual inheritance tax liability for your beneficiaries.
Gifts with reservation of benefit
Beware of gifting the house to your children without serious thought.
Transferring ownership of a family home to children whilst still living commonly comes up as an idea which individuals think will remove its value from their estate - and thereby perhaps protect it from needing to be sold later. However, as is always the way, things are not that straightforward.
If you transferred ownership to someone else but then remained resident in the house ‘rent free’, the idea of this reducing the value of your estate would not work. Instead, the full value of the house would be transferred back into your estate on death, regardless of whether you managed to live seven years or not.
That is because such a transfer is called a ‘Gift with reservation of benefit’. As you continued to benefit from the full value of the asset without any financial loss, it would not be deemed a Potentially Exempt Transfer (PET) and taper relief would therefore not apply - even though you had handed over the deeds.
Your house can be transferred to the ownership of your children and its value benefit from taper relief – IF, you either move out or you pay the new owners a commercial rent for the remaining time you are resident. However, even for those willing to stay and pay the rent, a transfer like this comes with significant practical considerations – for example, one of your children being declared bankrupt or perhaps becoming subject to divorce proceedings might mean you have to move out anyway.
There are a number of ways in which to reduce the impact of an Inheritance Tax bill on your beneficiaries without having to consider transfer of the family home whilst you still want to live there. If you think you have an issue, therefore, A&J Wealth Management can help make sure you are aware of all the options.
This can help prevent you making a mistake that could cost your beneficiaries perhaps even more than you were originally trying to save.
Insuring an IHT Liability
With the Treasury looking to haul in a record intake of Inheritance Tax (IHT) this year, individuals and families are always on the search for potential solutions to mitigate the IHT liability. One possible resolution is the use of a whole of life policy, written in trust, which covers the IHT liability with premiums paid both reducing and remaining outside of the estate.
As the whole of life policy is placed into trust, the premiums paid, are treated as gifts. Each UK resident is entitled to gift an annual exemption of £3,000 without causing any tax implications, and therefore this allowance can be utilised when paying premiums to your whole of life policy. Alternatively, if the premiums amount to more than £3,000 per annum then they are also treated as exempt from IHT. However, the important caveat is that you can prove that they are gifts from your normal income and do not affect your standard of living.
This means that any premiums paid into the whole of life policy can have a double effect. The proceeds of the policy, because they are written in trust, remain outside your estate for IHT purposes and premiums paid will continue to reduce the value of your estate, further reducing your estate's IHT bill and therefore providing a more substantial inheritance for your beneficiaries.
It is crucial that when the policy is set up, that it is written in trust. Unbiased’s Tax Action campaign found that approximately £530 million is paid unnecessarily each year in IHT due to life insurance policies not being placed into trust. By placing your whole of life policy in trust, the benefit amount will be paid to your trustees and remain outside your estate – so it will not be liable for IHT on your death. The beneficiaries of the trust can use this to help the personal representatives pay the IHT bill due on your estate.
Business Property Relief
Business Property Relief (BPR) was introduced in the 1976 Finance Act, enabling small, family owned businesses to be passed onto children, without being impacted by unpredictable IHT liabilities.
Since then, the exemption has been extended, and is now a widely recognised incentive to encourage investment in a wide range of different trading businesses. Regardless of whether the investor actually runs that business themselves.
Qualifying for BPR
To qualify for Business Property Relief, the business concerned must be trading in the UK. They cannot be investment companies and they cannot be listed on the London Stock Exchange.
Many family businesses would therefore qualify. However, there are also BPR qualifying investment opportunities through certain specialist managers who put together portfolios of certain AIM-listed and unquoted companies for the benefit of others.
It should be noted here that investment in smaller companies and small businesses carries a much higher risk than investing in larger, established and listed companies. Some of the reason for offering BPR on such investments is to offset some of this higher risk to the original value of investments.
However, regardless of any tax incentives available, if you are a moderately cautious investor, or someone who couldn't live with the unknown valuations and volatility of such, BPR related business investments are probably not appropriate for you.
On the plus side, though, if you are more adventurous and have the means to support BPR related investments, they do offer some advantages:
Unlike gifts into trusts, which qualify for full IHT exemption only after 7 years, BPR investments qualify for IHT exemption after being held for just 2 years (provided they are still held at the time of death)
The investor making the decision - you - retain full control over whether to hold that investment or sell and take the money back. As long as your realise this means they then lose their IHT exemption (though you can, of course, reinvest those proceeds and they will be exempt a second time after a further 2 years).
Buying shares is pretty straightforward compared to setting up trusts and life assurance. There is no need for a legal contract and no underwriting of health or other issues.
The value of a BPR-qualifying investment portfolio will depend on the performance of the companies it invests in.
With an investment like this, your capital will be at risk and you may get back less than you invest. Your tax treatment depends on your personal circumstances and may change in the future. Whether the investment qualifies for BPR will depend on the portfolio companies maintaining their qualifying status. HMRC will consider a claim for BPR based on the facts when a claim is made, including the relevant legislation in place at the time.
Investments in AIM-listed and unquoted companies are likely to fall or rise in value more than shares listed on the main market of the London Stock Exchange. They may also be harder to sell.
Past performance is not a reliable indicator of future results.
The Financial Conduct Authority does not regulate taxation and trust advice.
The information is based on our understanding of current HMRC tax rules applying for tax year 2019/20 which may be subject to future change.
All information on this website is for information purposes only and should not be interpreted as providing individual financial advice. It is important you understand the full benefits and risks of potential decisions as they relate to your individual circumstances and you should seek professional, regulated financial advice before embarking on any course of action.