Nicola Brant, Head of Estates, Tax & Succession, shared her thoughts in an article for ePrivate Client.
In the recent Autumn Statement, the Chancellor confirmed that he is extending the freeze on the Inheritance Tax (IHT) Nil-Rate Band (NRB) to 2028.
Currently, IHT is paid at 40% on the value of the estate over the NRB, which since 2009 has been set at £325,000 for an individual and £650,000 for a couple. There is also a Residence Nil-Rate Band (RNRB), which means if you are leaving your main home to children or grandchildren, you can benefit from an additional £175,000 allowance.
The freezing of these thresholds, instead of raising them in line with inflation, combined with the continued increase in the value of assets, especially property, has led many to describe it as a ‘stealth tax’.
Figures from HMRC in late October showed total IHT receipts since April are up to £3.5 billion – £400 million higher than this time last year. Extending the freeze until 2028 is projected to raise as much as an extra half a billion pounds for the Treasury.
So, how can professional advisers such as IFAs and wealth managers help their clients to minimise their exposure to IHT as the net creeps ever wider? The key is to plan ahead.
What are the rules on gifting money and assets?
An outright gift is one of the simplest ways to reduce an estate, for example, giving an adult child or grandchild a deposit for a house, or helping to pay for school fees or University. Such gifts are potentially exempt transfers (known as PETs) and so may be chargeable to IHT if you die within seven years of the gift. This is known as the ‘seven year rule’.
Some gifts are completely outside of an estate when it comes to IHT, and not subject to the seven year rule. Each person can give away £3000 a year and you can roll forward one year’s allowance if it was not used the previous year. They can also give up to £250 to an unlimited number of individuals each year. It is also possible to make regular gifts out of income, which are immediately exempt from IHT, though it is important to keep meticulous records of these.
Any money passing to a registered UK charity, whether through a lifetime gift or as an inheritance, is exempt from IHT. A lower IHT rate of 36% also applies, broadly speaking (although it is slightly more complex than this) so long as 10% of the residuary estate passes to charity.
Charities can also benefit by way of a post death variation. Even if no gift to charity is made under the deceased’s will, the beneficiaries of the estate can posthumously redirect some of their inheritance to charity in this way and have a two year window starting with the date of death in which to carry out a variation.
Making use of IHT exemptions
There are a range of exemptions that can come into play. Transfers between married couples and civil partners both in lifetime and on death are free of IHT due to the spouse exemption (with some narrow exceptions). There is no IHT exemption between non-married couples.
Everyone has an NRB of £325,000, which can be passed on free of IHT on death. However, this may be reduced by gifts and transfers into trust caught by the seven year rule. For those passing property to lineal descendants on death, an additional exempt amount of £175,000 is available (the RNRB). Both allowances are transferable between married couples, so if a person leaves their estate to their spouse or civil partner these allowances will be unused due to the spouse exemption but they can then be used on the second death. This means that up to £1million can be passed on to the children or grandchildren by a married couple free of IHT if all four allowances are fully available. While the RNRB is only fully available to estates worth less than £2million, there are measures that can be taken to bring the estate within this threshold.
Other exemptions which may be far more useful include exemptions on business property (Business Relief) and agricultural property (Agricultural Relief). Certain business property is relieved from IHT at a rate of 100% making it possible for a business to be passed down between generations without having to sell assets to fund an IHT liability.
What roles do trusts play in reducing exposure to IHT?
Placing some assets in a trust can mean they are no longer considered part of an estate when it comes to IHT. If a trust is created as a result of a variation within 2 years of an inheritance received from someone else an individual can potentially still control the assets and receive an income from them, without the assets forming part of their estate on death. Trusts are also a good option if a client wishes to give money or assets away to family, but would still like to retain some control.
The use of Deeds of Variation on the receipt of an inheritance is an under-utilised by very effective measure. If an individual already has an estate that is likely to be subject to IHT, it is a good idea to remove any inheritance from the estate for IHT purposes. If a Deed of Variation is used to create a trust, the individual will potentially still be able to benefit from the inheritance going forward.
Nominating a trust to receive death-in-service benefits from an employer or placing life insurance policies into trust can avoid inflating a spouse, civil partner or partner’s estate for IHT purposes, but the funds remain fully available to them should they be needed.
There are also other structures to consider. For example, if there is a large amount of available cash, a Family Investment Company may be an appropriate vehicle for longer term wealth planning. However, it is essential to take advice before setting up any kind of trust or estate planning structure as the rules are complicated and there are a range of tax implications to consider – (e.g. Capital Gains Tax).