In 2024, after years of rocketing property prices, more people than ever before are being stung by Inheritance Tax. To tackle this, the UK Government has frozen the inheritance tax threshold at £325,000 until 2028.
This means that zero inheritance tax (IHT) is paid until the value of an estate (property, belongings and money in the bank) exceeds £325,000. The value of the estate thereafter is subject to the standard UK Inheritance Tax rate of 40%.
Additionally, since 2017 beneficiaries have been able to take advantage of “Residence Nil-Rate Band.” This is called the Mains Residence Nil Band allowance (MRNB), and it means that IHT may not be due on the first £500,000 of your estate (£325,000 + an additional £175,000 allowance), if a mains residence is bequeathed to children (including adopted, foster, stepchildren or grandchildren. However, the Mains Residence Allowance is only applicable to estates with a value of £2 million or more.
Around 4% of families in the UK pay IHT. This may not sound like much, but there’s a reason for this. The average UK estate is £335,000, or thereabouts, according to online resources. Therefore, beneficiaries are only taxed 40% on the £10,000 difference between the IHT threshold and the value of the estate bequeathed them. Moreover, an estate left to a spouse or civil partner is exempt from IHT. This applies regardless of the estimated value of the deceased’s estate.
Navigating IHT can be challenging. Seeking Inheritance Tax advice is paramount. Get the right advice and you’ll be able to proficiently manage your tax liability, whilst ensuring your beneficiaries are left a welcomed nest egg to help secure their own future.
Read below to learn more about our top ten tips to avoid any unnecessary IHT complications and maximise the financial opportunities of your beneficiaries.
Make a Will
Making a Will is, arguably, the simplest way to make sure that your assets go to the people you want, for the reasons you choose. Let’s say you want to make sure that you want to donate a portion of your money to a charity, set up trusts or that your home goes to your children, you can stipulate that this in your will.
But it’s more than that. A Will allows you to choose how your assets are managed after you’re gone, allowing you to plan for and minimise your tax bill. The good news is that Inheritance Tax advice can help you to achieve this.
If you don’t have a will, the government will distribute your assets under the rules of intestacy. These are often employed when there are no immediate living relatives.
Remember: you can make changes to a will after somebody has passed on. This is known as effecting a Deed of Variation and can help to reduce Inheritance Tax and is often enacted when the intended beneficiaries already have Inheritance Tax liabilities.
A Deed of Variation is more common when grandparents have children who are beneficiaries, and yet they are already financially independent and do not require the money. A Deed of Variation can see to it that the grandchildren receive an estate.
Use Your Allowances
As we’ve already outlined, there are several allowances, exemptions and reliefs that you can use to reduce your Inheritance Tax liability. These include the Inheritance Tax threshold and Residence Nil Rate Band.
Additionally, you are entitled to two tax-free allowances of £325,000. This means that a total of £650,000 can be gifted before Inheritance Tax is due.
Moreover, the Mains Residence Nil Rate Band allowance is £500,000 per person. This means that for a mother and father who pass away and bequeath the main residence to a spouse, the total allowance before paying IHT is £1,000,000.
Giving Your Assets Away
There isn’t a limit on the number of gifts that you can make from your estate to reduce your IHT liability. However, gifting requires careful financial planning because you’ll need to calculate how much you can afford to gift whilst ensuring that your needs are met.
There are two forms of gifting: “chargeable lifetime transfers” and “potentially exempt transfers.” Remember: how you choose to structure your gift will determine how much Inheritance Tax is saved.
Chargeable Lifetime Transfers
Gifts made to discretionary trusts and corporations are known as “chargeable lifetime transfers.” An amount up to £325,000 can be deposited every seven years. Any amount in excess of £325,000 will incur a 20% tax charge.
Should death occur within seven years, the cumulative value of chargeable lifetime transfers will incur a 20% tax charge, if the transfer exceeds £325,000.
Income Gifts
If you’ve earned more than you’ve spent, you can make a gift out of your surplus income without a IHT charge. This is called the “normal expenditure out of income exemption.” The only caveat to this is that the gift must come from income and not capital. This can be tricky so it’s wise to seek Inheritance Tax advice to avoid IHT.
Don’t Look for Loopholes
Although gifts can be a sound way to maximise inheritance, there’re still rules that you need to adhere to. For instance, if you choose to sell a property to your son or daughter for less than its true market value it will be treated as a gift and subject to IHT.
People have gifted their children their home whilst still living there. This is called a “gift with reservation” and will still be treated as part of the estate. As such it will be subject to IHT.
However, should you continue to pay the market rent on, let’s say, your home after gifting it to your children at less than market value this will then classify the gift as a potentially exempt transfer.
Like anything else, be sure to seek IHT advice before making any big decisions about how your assets will be distributed in the event of your death.
Gift Exemptions
Some gifts are 100% exempt from IHT, whether you make them during your lifetime or on your death. But there are caveats and stipulations. For one, you may not pay IHT on any lifetime gifts you make, but if you’re disposing of chargeable capital assets, for example giving your children a second home, there are Capital Gains Tax implications.
Gifts Exempt from Inheritance Tax
- Gifts to Spouses: provided that you live in the UK, assets that you gift to spouses are not subject to IHT. This is a common tax planning strategy for married and civil partnership couples.
- Annual Exemption: you can legally gift £3,000 every tax year without paying IHT. Those people who haven’t used this allowance can carry it forward for a single tax year. It’s also an individual allowance, so, legally, a couple can gift £12,000 every other year.
- Wedding Gifts: Inheritance Tax doesn’t need to be paid when you choose to gift cash to a newly married couple. However, there is a cap on the amount of money people can gift. Parents and step-parents can gift up to £5000 tax-free. Grandparents can gift up to £2,500. Other friends and relatives can gift up to £1,000.
- Donations to Political Party’s or Charities: There’s no limit to the amount of money that you can donate to political parties or charities. Gifts to charities will reduce your Inheritance Tax Rate to 36%, provided that 10% of your “net estate” (the value of your estate after your Residence Nil Band and any debts or liabilities have been settled.
- Small gifts: any small gifts (less than £250) can be made without incurring any Inheritance Tax implications.
Be sure to get Inheritance Tax advice if you’re in any way unsure about your tax liabilities.
Trusts
If you put assets into a trust, they legally belong to the trustees (or the person or people responsible for managing assets.) This means that they aren’t subject to Inheritance Tax, provided three requirements are met. These are:
- Certainty of intention: it must be clear that the testator intends to create a trust
- Certainty of subject matter: it must be clear what property is part of a trust, and what property cannot be separated, for example property and bank balance
- Certainty of objects: it must be clear who the beneficiaries (objects) are
Trusts are often thought of as a more sophisticated way to manage IHT. However, trusts have their own tax charges and costs, so setting up a trust to circumvent IHT may not always be the best solution.
Remember: before setting up a trust always seek Inheritance Tax advice to determine if a trust is the right option for you and how to minimise IHT and other taxes and charges.
Open a Family Investment Company
Family Investment Companies (FICs) have become quite popular in recent years because rules have changed making them an excellent way of passing assets through generations. Why? Shareholders can be changed, something that’s especially helpful for people with historical family wealth.
The downside to FICs is that they’re taxed under normal company laws. This means that large asset distributions, particularly after a few years of formation, can become costly. There’s also the issue that depending on the government, the rate of applicable tax can make FICs less attractive to managing IHT.
Life Insurance
Life Insurance exists to protect beneficiaries, such as your spouse, from any negative financial consequences in the event of your death. However, if any life insurance policy isn’t placed in a trust then it may be liable for IHT. This separates it from your estate.
You can choose to set up either a “term” assurance policy or a “whole life” policy. A term assurance policy expires once you reach a certain age. A whole life policy covers you irrespective of the age you pass on.
Term assurance policies are generally lower cost whereas as whole life policies are more expensive. However, you’re guaranteed a policy payout.
The only drawback to Life Insurance is that it can become more expensive the older you get. The benefit to Life Insurance is that it gives you control over your assets in a way that other solutions do not.
Business Relief
Some investments and businesses are eligible for “Business Relief.” This means that some or all assets can be passed on tax-free.
To qualify for Business Relief, the deceased must have owned the qualifying assets, such as shares in an unquoted qualifying company, or a qualifying company listed in the AIM (Alternative Investment Market (AIM) for at least two of the last five years before the deceased’s date of death.
There are specific investments that allow you to buy into a scheme that qualifies for Business Relief. These schemes allow you to benefit from Inheritance Tax relief after two years, rather than seven, if the deceased has bequeathed this to you as a gift.
There are several advantages and disadvantages of Business Relief Investments, beyond avoiding IHT after 2 years. One advantage is that you can sell some or all of your shares at any stage (although this will lose Business Relief and reverse Inheritance Tax savings.) One disadvantage is that the underlying investments are risky, and shares may not be diversified, which poses an additional risk. If you’re in any doubt about whether Business Relief is the right approach for you, get Inheritance Tax Advice.
Tax Efficient Investments
Although investments can be a bit challenging to navigate, they are a sound way to minimise IHT as much as possible. Before making any financial commitment, don’t neglect to consult an experienced financial advisor.
You could choose to buy shares in one or more privately-owned companies that qualify for business relief. Providing that you hold shares for two years, you’ll qualify for business relief and be exempt from Inheritance Tax.
Investments include:
- Seed/Enterprise Investment Schemes (SEIS/EIS): SEIS investments that fall outside of Inheritance Tax after two years are subject to an income tax relief of 50%. EIS investments are subject to an income tax relief of 30%. Moreover, because Capital Gains Tax is deferred for 3 years, entities have access to capital within that 3-year period.
- AIM Investment Schemes: an AIM portfolio of diversified holdings gives you access to Business Relief. This provides investors with a portfolio of shares listed on the FTSE AIM 100 Index and provides investors with capital growth and dividend income opportunities. However, if you withdraw any capital growth, your estate will be responsible for paying Inheritance Tax.
Optimise Your Pension Potential
Pensions are categorised as being outside of your estate. Therefore, they can be passed on tax-free. Any IHT benefits depend on the type of pension you have.
Now, of course, pensions are complicated. Sound Inheritance Tax advice is required to navigate the benefits with success. The good news is that you can choose your spouse, children, grandchildren, or anyone else to receive your pension.
Defined Benefit Pensions: allow you to nominate a spouse or civil partner to receive a reduced rate of your pension (typically 50%.) Some defined benefit pensions also provide an income to children and non-married partners. You can also receive a lump sum, but this could be subject to tax depending on how the pension has been setup.
Defined Contribution Pensions: allow you to nominate anyone you choose. Should you pass on before the age of 75, a lump sum can be paid tax free, provided that the death benefits are paid within two years of the member’s death.
Stop Saving
The more assets you have, the bigger your Inheritance Tax bill is. Stop hoarding financial assets and, in theory, you won’t have to worry about passing on a huge IHT bill to any beneficiaries.
Your overall goal should be to reduce IHT liability, whilst safeguarding your own financial future. Don’t liquidate your assets overnight and make sure that you work with a financial advisor to help guide your decision-making.
Start Planning Today to Secure the Futures of Your Beneficiaries
Most of us don’t really think about IHT until later in life. However, it’s never too early to start safeguarding the financial future of the people you care about.
Consult an IHT advisor and form an effective IHT reduction strategy to mitigate your tax liability as much as possible throughout the years. Complete an honest appraisal of your financial life and consider all options available to you now and in the future. This way you’ll safeguard not only your own future, but the futures of those you care about.
Learn more about IHT and a whole range of financial issues by speaking to Ward Goodman’s team of highly trained accountants and financial planners today.
