8th September
general
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.
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.
Some ways in which your will can help to reduce IHT include:
Creating a will is simple and 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.
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.
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.
Trust Planning
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 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, and it’s worth taking advice.
Insurance
If you have an IHT liability, a simple and low-risk 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 immediate IHT charge.
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.
Regular insurance premiums are treated as gifts, so the tax position will depend on the amount and the type of trust you use.
Business Relief
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:
The main advantage is that these investments can qualify for relief after two years rather than seven. However, they are very high risk and there is always a chance that the relief could be removed.
Why it’s Essential to Plan Ahead
When you undertake IHT planning, it’s important to balance priorities, for example:
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.
