Inheritance Tax (IHT) is often dubbed “Britain’s most hated tax”, especially as it comes into effect when families are grieving.
Unfortunately for UK savers, HMRC’s take from IHT increased over the past year. In fact, according to FTAdviser, IHT receipts from April to October in 2021 were £3.6 billion, an increase of £600 million from the same period in 2020.
Despite this, according to MoneyAge, nearly three-quarters of people have taken no action to reduce their potential IHT liability. That means almost 75% of people are putting their family in a position where they may have to pay tax on their inheritance.
Interestingly, research published in FTAdviser revealed that this is particularly a concern for women, who are said to be exposed to around £430 million more in IHT than men.
The standard rate of IHT in the UK is 40%. That’s why it can be crucial to consider strategies that mitigate IHT, so you can pass on as much of your wealth to your loved ones as possible without having to pay this charge.
Here are five strategies you could consider to avoid contributing to these increasing IHT receipts.
You may be able to pass on up to £1 million tax-free
Before you start considering strategies to reduce a potential IHT bill, it’s important to note that every individual has a tax-free allowance before IHT is due on an estate.
This is called the “nil-rate band” (NRB), which stands at £325,000 in the 2021/22 tax year. There’s also an additional threshold called the “residence nil-rate band” (RNRB) which allows you to pass on a further £175,000 tax-free if you leave your main residence to your children or grandchildren.
That means you could pass up to £500,000, or £1 million if you’re married or in a civil partnership, to your beneficiaries without paying IHT.
However, any amounts over these key thresholds will typically be subject to the 40% charge.
5 strategies to mitigate Inheritance Tax
If you think your estate will exceed the NRB and RNRB, then it’s important to consider ways to reduce your IHT liability.
Here are five strategies you could consider.
Gifting is one of the most popular ways to reduce an IHT bill, allowing you to reduce the total value of your estate while simultaneously ensuring that your chosen beneficiaries receive exactly what you intend for them to have.
There are various gifting allowances that you can make use of to reduce your IHT liability:
- The gifting annual exemption allows you to gift up to £3,000, or up to £6,000 as a couple, each tax year to whoever you’d like with this amount falling outside of your estate.
- You can make an unlimited number of small gifts up to £250 to whoever you’d like, except for the person who receives your annual exempt amount.
- You have an additional exemption for wedding gifts, allowing you to pass up to £5,000 to your children, up to £2,500 to your grandchildren, or up to £1,000 to other friends or relatives, with these amounts falling outside of your estate.
The seven-year rule
Outside of these exemptions, you can theoretically pass on as much as you’d like to anyone of your choice and have it fall outside of your estate, provided that you outlive the gift for at least seven years.
If you die within these seven years, your gift may be subject to IHT, with the rate depending on your specific circumstances.
If you do decide to gift money or assets, make sure you keep accurate records of what you’ve given and to who. That way, your executors will be able to evidence these gifts to HMRC when calculating the value of your estate.
At Britannic Place, we can help you by taking notes of any gifts you make. We can then pass these on to the executors at the appropriate time to ensure that the gifts are not included in your estate.
Please speak to us to find out more about how we can help in this area.
2. Drawing income tax-efficiently
Typically, when your executors come to calculate the value of your estate, the money in your pension will fall outside of it, depending on your age and whether you have started to take an income from your pension.
So, if you considered drawing your retirement income from other sources, such as savings or from liquidating investments, this could reduce the overall value of your estate.
In turn, this would mean your beneficiaries would face a smaller IHT bill, while also allowing them to inherit the remaining value in your pension. You must nominate the beneficiaries of your pension.
Bear in mind that any non-ISA investments you sell may be subject to Capital Gains Tax (CGT) if they’ve risen in value since you bought them.
It’s important to consider taking financial advice before making decisions with your pension like this. Otherwise, it could have an impact on your retirement lifestyle.
3. Charitable donations
One other option for reducing your tax bill is to leave a portion of your estate to charity in your will.
Under HMRC rules, if you leave at least 10% of your estate to charities or political parties in your will, your IHT rate will be reduced to 36%.
That means you’ll be able to support causes that are close to you, while also reducing your overall tax bill.
4. Holding assets in trust
A trust is a way of transferring ownership without giving up complete control of the trust property. A trust is usually created by a document called the “trust deed”, which names the people involved and sets out the terms of the trust.
Trusts are often used in IHT planning as a means of removing assets from an individual’s estate without losing control of, and possibly some of the benefits from, those assets. However, care must be taken to ensure that any such transaction does not fall foul of the HM Revenue & Custom’s (HMRC) “gift with reservation” rule.
Please note that all trusts with a UK tax consequence are required to be registered with HMRC and detailed information must be provided.
Trust planning can be complicated so please speak to us if you’d like to know whether using a trust is an appropriate choice for you.
5. Business Relief
Business Relief (BR) is a tax relief provided by the UK Government as an incentive for investing in specific types of trading companies. It was introduced by the government in the Inheritance Tax Act 1984 and has since been extended to investments in certain types of unquoted companies (not listed on the main stock markets) to encourage investment into this area.
Once assets qualifying for BR are held for two years, they are exempt from IHT (providing they are still held at the time of death). The shareholder does not have to be directly connected with the running of the company, for example as a director or employee, to benefit from the relief.
The definition of “unquoted” is not quoted on a recognised stock exchange, although shares quoted on the Alternative Investment Market (AIM) are also eligible for this relief.
The unquoted company would have to meet certain criteria to be eligible for BR, including being a “trading” company within the meaning of the relevant legislation for relief to apply to its shares. A shareholder would become eligible for BR once the shares had been held for at least two years.
It is important to note that investing for Business Relief does come with particular risks and we would strongly suggest that advice is sought before doing so. Please speak to us if you would like to learn more about Business Relief.
Using life insurance to pay the remaining bill
If you’re still left with an IHT bill after you’ve implemented strategies like these, you could also consider using a life insurance policy, provided that it’s held in trust.
Trusts typically fall outside the value of your estate. So, if you take out a life insurance policy in trust with a payout equivalent to your expected IHT bill, this will allow your family to quickly access the funds on your death.
Your family can then use the life insurance money to pay the outstanding IHT bill, allowing them to access the full value of your estate.
So, even if you’re left with a bill, this method can allow you to remove the stress for your family of having to worry about paying IHT.
Work with a planner
If you’d like help finding the right strategies to mitigate a potential IHT bill in your personal circumstances, please get in touch with us at Britannic Place.
Email [email protected] or call 01905 419890 for more information.
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