Inheritance tax: Making your estate more efficient

Rising property prices mean more families are being impacted by Inheritance Tax (IHT). In a recent article for The Money Pages, Sarah Nettleship explains how, by planning ahead, you can reduce your exposure.

In 2018/19, only 3.7% of UK deaths gave rise to an inheritance tax (IHT) charge. Indeed, as a private client solicitor, I have experienced great joy in telling clients that their estates are unlikely to be subject to this most hated of taxes but such occasions are becoming a rarity. HMRC collected £6.054bn in IHT receipts in 2021/22 and it is forecast that receipts will reach £8.3bn by 2026, catching more than 200,000 people over the next four years.

IHT reliefs have not caught up with rising property prices even with the introduction of the Residence Nil Rate Band (RNRB); a convoluted and complicated relief which nonetheless, together with the Nil Rate Band (NRB), lifts an estate worth less than £1million out of the IHT net for a married couple. It has, of course, been unhelpful that the NRB has been frozen since 2009 at £325,000.

So, how can you avoid paying IHT as the net creeps ever wider?

The answer is forward planning! It is never too early to consider how your estate can be made more tax efficient.

Gifts

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. 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 clock’. When making gifts, each person can give away £3000 a year which is immediately exempt and not on the seven year clock. You can roll forward one year’s allowance if it was not used. You 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 to assist your executors in claiming this relief. If you wish to give money or assets away but would still like to retain some control, a transfer into a trust may be more appropriate, though there are limits on the amount that can be put into trust before a tax charge arises. There are other structures which may also be useful. If you have a large amount of available cash, a Family Investment Company may be an appropriate vehicle for example. It is important to consider the Capital Gains Tax implications of any gift.

Making use of exemptions

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). Contrary to popular belief, there is no IHT exemption between non-married couples so if you are not married to your partner or in a civil partnership with them, your estate may face IHT when you leave your estate to them and it will not be possible to transfer your NRB or RNRB to them to use on their death. Each person has an NRB of £325,000 which can be passed on free of IHT on death. This may be reduced by gifts and transfers into trust caught by the seven year clock. 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 from married couples 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 exceptions 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 bill. Such assets need only to have been owned for 2 years prior to death.

Ensuring your will is tax efficient

Not all wills will help to save IHT but having a will drafted by a solicitor will ensure that the IHT implications of the structure of the Will are properly considered and dovetail neatly with the lifetime estate planning that you have put into place. For example, a solicitor can advise on the most tax efficient way to provide for an unmarried partner or how to preserve Business Relief which would otherwise be lost if the whole estate is left to a spouse or civil partner. Of course, not all decisions you make regarding your will be tax driven, and it is more important that your Will ensures your estate is given to those you wish to benefit, but a solicitor can make sure that this is done in the most tax efficient way.

Other planning measures

It is also possible to reduce your IHT exposure on assets you may not have even considered. For example, nominating a trust to receive your death-in-service benefits from your employer or placing your life policy into trust can avoid inflating your spouse, civil partner or partner’s estate for IHT purposes but the funds remain fully available to them should they be needed. Another underutilised measure is the use of Deeds of Variation on the receipt of an inheritance. If you already have an estate which is likely to be subject to IHT, it is a good idea to remove the inheritance from your estate for IHT purposes. However, if you use a Deed of Variation to create a discretionary trust, you will still be able to benefit from the inheritance going forward.

If you are concerned that your estate may be subject to IHT on your death or the death of your partner, it is important to take legal advice to reduce your estate’s exposure to this tax. If you already have a financial advisor or accountant, a solicitor can work with your existing advisors to make sure your estate is tax efficient.