Is Inheritance Tax Inevitable?
A Political Hot-Potato
Without a doubt, inheritance tax is a polarising subject.
Many feel that it is an unfair tax, levied on people already having paid significant amounts of income tax and capital gains tax through a lifetime of work, and as a consequence depriving their loved ones of hard-earned financial security.
Others believe that in a time of increased disparity between the richer few and the poorer majority, it is a fair re-distribution of wealth.
General inflation and house price inflation over the last few decades, along with inheritance tax allowances being reduced, has meant that more people are likely to have their estates subject to this tax.
Recently, there has been speculation in the news that the UK government is considering abolishing inheritance tax, as a pre-election vote-winner.
This is viewed by many as a positive step, but with government debt so high, and a recent increase in interest rates, it would seem fiscally irresponsible for the government to reduce one of the methods it uses to collect the cash to repay its liabilities.
A recent report by the Office for Budget Responsibility implied as much this month.
In the rest of this blog I will outline the basic facts as they stand about inheritance tax, and what measures one can take to reduce its impact, in the event that it remains in its current form after the election.
How Is Inheritance Tax Calculated?
Inheritance tax is a levy by the UK government, on the estate of someone who has died.
The deceased's estate is liable to IHT on all property, possessions and money above any allowances.
Following death, the executors of any Will must calculate the value of all assets, deduct any liabilities and the remainder in your estate is liable to inheritance tax.
If you you are a UK domicile, IHT is payable on your assets anywhere in the world, but if you don't consider the UK your home then only your UK assets will be included in the tax calculation.
To avoid late payment penalties, executors must pay inheritance tax to HMRC within 6 months following death.
The inheritance tax rate is currently 40% on a taxable estate.
Which Assets Are Included?
Anything classed as an asset is included. If you have an asset which is jointly owned with somebody else, then your share of the asset falls into your estate.
The list of items which are included may surprise you; included are:
Property
Bank/Building Society balances
Investments
Shares
ISAs
Antiques
Jewellery
Personal chattels (encompassing most other possessions),
Vehicles
Life insurance policies (not held in trust)
Gifts (made in the 7 years before you die...in varying proportions based on timing)
The asset value is determined to be the value at the date of death.
Is Anything Excluded?
Actually yes, some types of asset are considered to be outside of your estate for inheritance tax purposes and are, therefore, not subject to inheritance tax.
Anything that is settled into particular types of trust, are deemed to be outside of your estate for inheritance tax purposes, and this can include life insurance policies and pensions.
As mentioned before, outstanding liabilities will be repaid from the deceased's assets, reducing the value of their estate for inheritance tax calculations, and as such even such costs as funeral expenses are generally an allowable deduction from a person’s estate.
Gifts & Inheritance Tax
Some people believe that they are able to gift assets from their estate to friends or family to avoid inheritance tax.
There is some truth to this, but it is a complicated area, and it would be easy to fall-foul of the rules.
Gifts made by a person within 3 years of their death will be added back into their estate, so in essence they are not classified as having been removed.
If, however, they die more than three years, but less than seven years after making a gift, then their gift will be subject to a reduced rate on inheritance tax.
This is summarised below:
If they die seven years or longer after making a gift, then the gift will be exempt from inheritance tax.
So Is Inheritance Tax Inevitable?
The title question for this blog suggests that there might be ways to reduce or potentially avoid inheritance tax, and with careful estate planning, there are certainly ways that one can.
1. The Basics - A Will
Whilst a will is not necessarily a method for mitigating inheritance tax in of itself, the process of specifying where your assets are directed, which a will is designed for, can help you to direct assets into tax-efficient structures (like trusts), or into charitable donations which can reduce your overall inheritance tax rate from 40% to 36% (subject to conditions).
Additionally, if you die without a will (intestate) then the government will decide how your assets are distributed, which leaves less scope for tax efficiency as the rules of intestacy distributions are very specific.
Creating a will doesn't need to be expensive or time-consuming. Click the button below for fast and inexpensive online will creation in about 10 minutes.
Setting Up A Trust in Your Will
When you set up a will trust, you create a legal arrangement where you give cash, property or investments to someone else to look after them for a beneficiary. An example of this is if you choose to set up a trust fund for your grandchildren’s education costs. On your death, any assets that are held within a trust are likely to be exempt from inheritance tax.
2. Gifts
As mentioned previously, depending on the timing of gifts relative to ones death, they can be exempt from inheritance tax, but as most of us don't know when we will depart, gifting should form part of a long-term estate management strategy.
Gifts are classified by HMRC as one of either a “potentially exempt transfer” or “chargeable lifetime transfer”.
Potentially Exempt Transfers
You can make unlimited gifts as a potentially exempt transfer, and if you survive for seven years or more after the gifts they will fall outside of your estate for inheritance tax purposes.
However, as the chart earlier highlighted, if you die within seven years of the gifts, then some or all of them will be included in your estate for inheritance tax purposes.
The amount of each gift that is subject to inheritance tax will depend when the gift was made. If it was made within 3 years of death, then the full amount of the gift is subject to inheritance tax.
If it was made between 3 – 7 years before your death, then some of the gift will be subject to inheritance tax. (see the "7 Year Gifts Rule" diagram above)
Chargeable Lifetime Transfers
Any gift that is not a potentially exempt transfer, is a chargeable lifetime transfer.
HMRC allows you to utilise your £325,000 inheritance tax allowance to offset these gifts, but an immediate 20% tax charge is levied on any such gifts which exceed the allowance within a seven year period.
CLT gifts in excess of £325,000 within 7 years of death will attract a further inheritance tax charge of 20%, taking the tax paid to 40%.
3. Allowances
There are various different types of allowances, exemptions and reliefs which can reduce your inheritance tax liability. This includes the nil rate band, the residence nil rate band and annual gifting allowances.
Nil-Rate Band (NRB)
You don’t pay inheritance tax on the first £325,000 of assets. This is known as your nil-rate band (NRB).
If you die and leave your assets to your spouse, they will inherit your NRB and can add it to theirs. They will then have two nil-rate bands, enabling them to gift up to £650,000 before inheritance tax is due.
Residential Nil-Rate Band
The residential nil rate band (RNRB) is an extension of the NRB. This provides any homeowner with an additional £175,000 to add to their £325,000, however, this must be set against your main residence net asset value and be passed to a direct descendent (child or grandchild).
If you die and leave your main residence to your spouse, they will inherit your RNRB and NRB. They will add your NRB (£325,000) to your RNRB band (£175,000) and will also have the same allowances themselves...providing a total of £1,000,000 which they can pass directly to their children without any inheritance tax liability.
4. Use Exemptions
Some gifts are exempt from inheritance tax:
Gifts to spouses
Annual exemptions
Wedding gifts
Gifts to charities and political parties
Small gifts
Gifts To Spouses
Provided they live in the UK, gifts to a spouse during lifetime or upon death are exempt from inheritance tax.
Other tax saving measures for married couples are explained in this article.
Annual Exemption
You can gift £3,000 each tax year without attracting inheritance tax. You can carry any unused exemption forward by one tax year, allowing up to £6,000 if this is the case.
Wedding Gifts
Each parent or step-parent can gift up to £5,000 tax-free to their newlywed sons or daughters, each grandparent can give up to £2,500, and other relatives and friends can give up to £1,000.
Charities & Political Parties
Gifts to charities in your Will of at least 10% of the net estate, reduce the inheritance tax rate on the remainder of your estate to 36% from 40%. This can actually be quite beneficial in some cases in saving tax, particularly on large estates.
Small Gifts
Unlimited small gifts of £250 maximum per recipient can be made without any inheritance tax implications.
5. Use Business Relief
Some businesses and investments are eligible for “Business Relief” which allows assets to be passed on tax-free.
Business Relief
Some types of investments qualify for Business Relief. If you hold these shares for two years, their value on your death will qualify for this relief, making them exempt from inheritance tax.
Examples of investments that qualify for business relief include:
• Enterprise Investment Schemes (EIS)
• Seed Enterprise Investment Schemes (SEIS)
• AIM investments
The deceased must have owned the qualifying assets for at least 2 out of the last 5 years before death and at the date of death, for the assets to qualify.
Business Relief also applies a 50% reduction for business property and buildings, machinery and any shares controlling more than a 50% voting interest in a listed company.
100% Business Relief is received for unlisted shares and certain AIM-listed and EIS investments.
6. Life Insurance
Any life insurance policy can be written ‘in trust’ to separate it from your estate to avoid any inheritance tax. If done correctly, the net result is that your beneficiaries will receive your whole estate without a tax deduction.
If life insurance policies are not specifically written into trust then they may be paid into your estate upon your death, increasing your estate value, and potentially creating an additional inheritance tax burden.
7. Trusts
If you put assets into a trust, they no longer belong to you, and as such, are not included in your estate for inheritance tax calculations. The seven year rule does still apply.
Depending on the type of trust you use, you can retain some control over how the money is used and who benefits from it.
However, trusts have their own tax charges and costs, and the inheritance tax benefits should be weighed against the administration and charges that a trust may entail.
Before setting up a trust, you should consult with an independent financial adviser, like Fane Financial Services www.fanefinancialservices.co.uk.
Trusts can be complicated, and an estate planning team with extensive experience writing and managing trusts should be consulted before utilising one, to be sure it is right for you.
8. Tax Efficient Investing
With tax-efficient investing, you might effectively avoid inheritance tax altogether.
These investments tend to be more complex, that’s why working with an experienced financial advisor is essential.
The main categories for tax efficient investing as they relate to inheritance tax are:
Gift and Loan Trusts
A gift and loan trust plan is a flexible inheritance tax planning strategy. It provides you with a regular stream of income whilst gradually reducing the value of your estate. You can also withdraw your money at any time.
Benefits
✓ Gradual inheritance tax savings on the investment growth
✓ You retain access to the capital and can withdraw this at any time
✓ You receive a regular income each year from the investment bond tax-free
✓ On your death, the capital can be inherited by your beneficiaries immediately without waiting for probate
Discounted Gift Trusts
A discounted gift trust provides you with an immediate inheritance tax saving. The inheritance tax saving will depend on your age/health and how much income you withdraw.
You will receive a regular tax-free income and retain control over who benefits from the capital. The main downside is that you do not have access to the capital yourself.
Pensions
Pensions are not only extremely tax efficient at the point of depositing into them, they also offer certain protection from inheritance tax when they are assigned to specific beneficiaries.
The chart below shows some of the pension tax treatment depending on age at death:
If you’re unsure about pension death benefits and want to discuss ways to improve your inheritance tax efficiency, contact an independent financial adviser today.
As you can see from this article, inheritance tax is multi-faceted, and each person's requirements will be different, so we would always advice that you speak with a financial adviser to ensure that you receive personalised advice on estate planning.
Lifestyle Advisor, Poole
Fit to Retire Ltd is a lifestyle advisory business based in Poole, Dorset.
We provide estate planning services and health and wellness advice, and we introduce our clients to experienced and respected financial advisers for specific financial advice on savings, investments, inheritance tax planning and protection (including insurance products).
Contact us by telephone on 01202 070071.
Contact us by email at clientcare@fittoretire.co.uk
Fit to Retire Ltd is located at: FOUNDRY, The Dolphin Centre, Poole BH15 1SZ
Whilst this article provides some information related to personal finances, it should not be construed as personal financial advice. For personal investment advice please contact Fane Financial Services.
It is important to remember that investments can go up as well as down in value, and any investment you make should be assessed for its risk profile and its appropriateness for your circumstances.
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