Chartered Financial Planner Alex Pickles explores the basics of mitigating Inheritance Tax.
Many people find the idea of discussing Inheritance Tax (IHT) uncomfortable, either due to the complexity of the rules or simply the fact that considering what will happen to your money when you’re gone isn’t the cheeriest of topics. Regrettably, this leads many to put off this type of planning until it is too late to make a difference.
You can understand why people find this area of financial planning so confusing – there are multiple reliefs, allowances and exemptions to consider, and it can be very frustrating to try to determine which are most suitable (or relevant) to use. Some parts of IHT planning, however, can be straightforward to action and can have a powerful effect on the preservation of your wealth. As the former home secretary, Lord Roy Jenkins, famously stated: “Inheritance Tax is a voluntary tax, paid by those who distrust their heirs more than they dislike the Inland Revenue.”
When is IHT payable?
Very simply, when someone dies the value of their estate is assessed to confirm if IHT is payable, and this will need to be paid before any assets can be distributed to the beneficiaries. How much tax your estate will pay depends on the total value of your estate minus any debts. This will likely include your home and possessions; savings and investments; and possibly even gifts to others if they don’t qualify for exemption.
What allowances do I have?
The amount you can pass on without paying any IHT is currently £325,000 – otherwise known as the ‘Nil Rate Band’ (NRB). Whilst many personal allowances have increased over time, this one has remained at the same level for several years now. The value of your estate above the NRB will be taxed at 40%.
Transfers between married couples or registered civil partners are exempt from IHT and do not impact the individual’s NRB. Their unused NRB can also be transferred to their partner when they die, which means that in many cases, couples do not pay IHT until the value of their joint estate exceeds £650,000.
An additional allowance known as the ‘Residence Nil Rate Band’ (RNRB) is now also available if your home is passed to ‘direct descendants’ (typically either child or grandchild). This is currently £175,000 per individual and can again be transferred to a surviving spouse or registered civil partner if not used fully on first death. This allowance does come with a few conditions:
- – The allowance only applies to your home (not to other property you own).
- – You can only receive the allowance up to the value of the property.
- – For those whose total estate exceeds £2 million, the RNRB is gradually reduced:
- for every £2 that your estate exceeds this value the allowance is reduced by £1 and
- is lost entirely if your estate exceeds £2.35m for an individual or £2.7m
- if two allowances are available.
How can I reduce my IHT bill?
So now that we know our available allowances, how can we plan effectively to stay within them?
Spend it! Arguably the easiest and most enjoyable way of reducing your IHT bill is to spend your money whilst you are alive, reducing the estate that will be passed to your beneficiaries on death.
Get married – Whilst not the most romantic motivation, for an unmarried couple this can be a straightforward way of ensuring that your estate is passed to your partner free of IHT on death. This was famously done by Sir Ken Dodd prior to his death, saving an estimated £2 million in tax.
Gifting – IHT gifting rules permit you to gift up to £3,000 to others every year without having to worry that this will still be deemed part of your estate on death. Additionally, you can make regular gifts from your income, providing that these don’t impact your quality of life. For more substantial gifts, however, the rules become more complex.
Trusts – Most investments and forms of life cover can be placed in trust for your beneficiaries. Assets held in trust are usually deemed outside of your estate and therefore exempt from IHT, although this will depend on criteria such as the value of the assets and how long ago they were placed in trust.
Contributing to a pension – Although many only consider pensions as a savings wrapper for retirement , they can be one of the most tax-efficient ways to pass on your wealth and can immediately reduce the value of your estate for IHT purposes.
This is by no means an exhaustive list of IHT solutions, and it is safe to say that the rules surrounding these are often more complex than they first appear. Depending on your individual needs and objectives, you may even find that the best plan for you involves combining several of these solutions, which is why we would always recommend seeking independent financial advice before making any decisions. Nevertheless, with careful planning you can reduce your IHT bill and potentially avoid thousands of pounds being passed to HMRC rather than your loved ones.
Alex Pickles APFS
Chartered Financial Planner
Read more of our articles about Estate Planning.
The scenario included is for information purposes / general guidance only and should not be interpreted as advised recommendations.
Information is based on our current understanding of taxation, legislation, and regulations. Any levels and based of, and reliefs from, taxation are subject to change.
The Financial Conduct Authority does not regulate tax advice, trust planning, Will writing or legal services.
The details relating to the laws of England & Wales are correct at the time of publication, and legislation may change.
A pension is a long-term investment – the fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.