Cushioning the blow
Five effective strategies to reduce the impact of Inheritance Tax.
HM Revenue and Customs (HMRC) is raising more from Inheritance Tax (IHT) than ever before. Official figures show that receipts have surged by 10% year-on-year since 2009/10, and the number of estates paying it has almost doubled since 2011 as a freeze in the IHT nil-rate band has put more families within range.1
However, with some careful planning, people can legitimately reduce their IHT liability or possibly pay nothing at all. So if you think your estate might have to pay IHT, here are five things you can do to reduce HMRC's cut.
1. Use your lifetime gifts exemption
Perhaps the most obvious way to reduce an IHT liability is to use your gifting exemption. You can make gifts of up to £3,000 in total in any tax year without attracting IHT. If the gifting exemption is not used in one tax year, it can be carried forward to the next, enabling some individuals to remove as much as £6,000 from their estate in just one tax year. These exemptions are personal, so a couple could remove £12,000 from their joint estate in just one tax year by using the carry forward provision.
Where the exemption is used over a number of years, a potential IHT bill may be significantly reduced or even eliminated. Moreover, that money could provide younger family members with an invaluable head start in life. (Remember that saving for children is typically a longer-term exercise, so the potential for growth is more likely to be achieved by investing the money rather than leaving it in cash.)
You can, of course, give away more than the annual gifting exemption if you want to, but you must live for at least seven years from the date of the gift for it to completely leave your estate. If you die within seven years, and the cumulative value of the gifts exceeds the nil-rate band, IHT is payable on the excess at tapered rates shown in the table.
|Less than 3 years||3 to 4 years||4 to 5 years||5 to 6 years||6 to 7 years||7 or more years|
Be aware that if you give something away and continue to use it, then it is still counted as part of your estate. For example, if you give your home to your adult children (who live elsewhere) and continue to live there rent free, the property is unlikely to escape IHT. This is where the rules can get a bit more complicated, so it is always best to seek financial advice.
2. Give away excess income
Those with sufficient surplus income may want to take account of the ‘normal gifts out of income’ rule – if you make regular gifts out of income and in doing so don’t affect your standard of living, they are exempt from IHT. This exemption is only limited by your personal resources and the amount of spare income available to give away.
Keeping a record of who you made the gifts to, their value and the date they were made, should speed up the process of any checks made by HMRC. You could also consider establishing a standing order (e.g. to provide funds to pay for grandchildren’s school fees) as it supports the intent to make the gifts on a regular basis. If you can satisfy the conditions for the exemption, the gifts escape IHT as soon as they are made, and you do not have to survive for seven years.
3. Save more into a pension
In the majority of cases, pensions are outside the scope of IHT. Nevertheless, until recently, heirs were faced with a 55% tax charge when they inherited a pension in drawdown. Thankfully, these rules no longer apply and a pension can be paid as a lump sum or income to any beneficiary with absolutely no tax to pay if you die before the age of 75.
If you are 75 or over when you die – and that is likely to be the case for most individuals – your heirs do pay tax, but only when they take the money out. Even then, the tax is paid at their own Income Tax rate. Therefore, making extra contributions to a defined contribution pension should be on your list of potentially worthwhile estate planning options.
(Note that if you make a pension contribution while you are in serious ill health and don't survive to take your retirement benefits, there may be a tax charge to pay, as you may be deemed to have deliberately tried to avoid IHT. Again, to reduce the possibility of a disagreement with HMRC, it is sensible to seek professional financial advice.)
4. Review your Will
Who you leave money to in your Will* might affect whether or not IHT is payable. For example, money or property left to a spouse or registered civil partner does not attract IHT. But if your estate passes to a child (or doesn’t qualify for relief as an agricultural or business asset), then IHT will have to be paid on anything over the nil-rate band.
This means couples often leave everything to each other. However, you could make provisions to ensure that your nil-rate band legacy is left to your children, via a trust for example, with the rest of your estate going to your spouse or civil partner. This could ensure assets are passed to children and other loved ones without attracting IHT.
The important thing is to make a Will and review it regularly. Without one, your estate will be divided up according to the rules of intestacy – which do not guarantee that your spouse will inherit your whole estate. If your children end up inheriting part of your estate, and their share is worth more than the individual IHT nil-rate band, they could be liable to pay 40% tax on anything they inherit over that amount.
5. Buy life insurance
In circumstances where your IHT liability cannot be eliminated, it can be worth giving some thought to tax-efficiently providing for it through appropriate life assurance held in trust. Taking out a life assurance policy with the sum assured matching the potential IHT bill could save your family or dependants having to sell any of your assets to cover the costs. Failing to write the policy in trust will mean that the sum assured will be paid to your estate, which would only increase the IHT liability.
Recent research by Direct Line revealed that just 20% of people with a life insurance policy have placed it into trust, and almost as many didn’t even know it was an option.2 Whilst there are some situations where it isn’t appropriate, taking advice to establish whether existing life policies should be written in trust could be a very useful place to start minimising a potential IHT bill.
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief generally depends on individual circumstances.
*Will writing involves the referral to a service that is separate and distinct to those offered by St. James's Place. Wills and Trusts are not regulated by the Financial Conduct Authority.
1 HMRC, Inheritance Tax Statistics 2015 to 2016, August 2018
2 https://www.directlinegroup.com/media/news/brand/2018/081018.aspx, 8 October 2018