Consider your options: How estate planning early can help your loved ones in the future

A recent article in the Financial Times highlighted that over 13,000 families faced surprising Inheritance Tax (IHT) bills – as high as £1.4mn in some cases – as a result of donors dying within seven years of making a lifetime gift. This is a key reminder of the importance of estate planning at the earliest opportunity. When it comes to estate planning, there are many issues to consider and this article looks at the options to explore in your lifetime in order to protect your loved ones and to minimise your exposure to IHT.

What is the seven year rule?

Individuals can make gifts of unlimited value during their lifetime, which are known as Potentially Exempt Transfers (PETs) as they become exempt from IHT if the donor survives  the gift by seven years (known as the ‘seven year rule’). Because the donors in the FT article did not survive the gifts by at least seven years, these gifts were taxable on their death.  The first £325,000 of gifts is covered by the donor’s tax free allowance (to the extent that is still available on their death) and the balance of the gifts over and above this figure is taxed as follows:

• Gifts made within 3 years of the date of death – 40%
• Gifts made 3-4 years prior to the date of death – 32%
• Gifts made 4-5 years prior to the date of death – 24%
• Gifts made 5-6 years prior to the date of death – 16%
• Gifts made 6-7 years prior to the date of death – 8%

If IHT is due on any lifetime gifts, the primary responsibility to pay that falls on the recipient of the gift, unless the donor provides to the contrary in their will.

The figures highlighted in the FT article came from a freedom of information request made by financial planners RBC Brewin Dolphin to HM Revenue & Customs. They showed that taxpayers owed £5.76bn in IHT during 2020-2021, including 13,380 failed PETs. This was driven by increased mortality during the coronavirus pandemic and a freezing of the threshold at which IHT applies. The threshold of £325,000 has not been increased since 2009 and is due to remain at the same level until at least 5 April 2028. These figures show just how important appropriate estate planning is during your lifetime, and the earlier the better.

Lifetime estate planning options to consider

While lifetime gifting forms an important part of estate planning, there are many elements to consider and it is better to start as early as possible to give yourself more options. These can include:

1. Ensuring you have a valid will in place – This is one of the most important documents you will ever make, and sets out how you want your assets to pass.  A will can also help you to achieve your wishes tax efficiently.  Wills should be updated regularly. A good rule of thumb is to update your will every match (marriage), hatch (birth) and dispatch (death). You do not want to die intestate (without a will) as your estate will not necessarily go where you may expect or want it to: as legislation sets out who will benefit in that situation.
2. Setting up a trust – Setting up a trust is a particularly good option if you want to give away money, but would still like to retain some control. There is a variety of trust types, all with different tax consequences. You should seek professional advice when deciding which type of trust is most appropriate for your individual situation.
3. Consider gifts – As mentioned above, lifetime gifts are typically subject to the ‘seven year rule’. However, some gifts are left out of IHT net and would not be subject to the ‘seven year rule’ even if the donor doesn’t survive for that period. These types of gifts include:

• General gifts – You may gift £3,000 a year and are able to roll forward one year’s allowance if not used in the previous year. You may also gift £250 to as many people as you want people each year, but you cannot use this allowance in conjunction with the £3,000 allowance.
• Gifts out of surplus income – Regular gifts made out of surplus income rather than capital are also exempt from IHT, but it is vital to keep meticulous records of these to be able to prove that they were from income.
• Gifts for weddings and civil partnerships – These have special rules allowing you to give up to £5,000 to a child or £2,500 to a grandchild who is getting married. These gifts will be exempt from IHT provided they are made before the wedding takes place.
• Gifts between spouses or civil partners – There is no IHT to pay on any gifts between spouses or civil partners, providing the recipient spouse is domiciled in the UK.
• Passing money to a registered UK charity – Gifts to charity during your lifetime or on your death are free from IHT and will reduce the value of your taxable estate. If you leave broadly ten per cent of your estate to charity on your death, then the rate of IHT on your taxable estate will be 36 per cent rather than the normal 40 per cent.

With any type of gift it is important to ensure that the person making the gift doesn’t receive any future benefit from the gift as that could not only mean the gift is ineffective for IHT purposes, but potentially lead to an increase in IHT due to complex anti-avoidance provisions.  By way of example, if you are considering giving away your holiday home to your children, you shouldn’t assume you can continue to use it unless you retain a share in the property, or you pay a market rent when you do use it.It is important to seek legal advice when considering estate planning, especially for IHT planning purposes, as it is a complex area and other taxes can also arise. For further information, please do get in touch.

Give early, give often, but only give what you can afford.