Inheritance Tax (IHT) is often overlooked as a financial planning need, as people underestimate their total wealth and therefore often fail to take the necessary action. We are seeing a demand for more and more financial planning for our clients in this area.
Inheritance Tax was first introduced in 1796 as a levy on the wealthy, but more and more estates are being caught by IHT. In 2018, HMRC reported that IHT receipts had now risen to £5.221 billion. So how can you reduce your Inheritance Tax bill so that you preserve more of your wealth for your chosen beneficiaries?
Understanding the allowances
Inheritance Tax is payable at 40% on the value of your estate on your death, over and above your Nil Rate Band allowance – currently set at £325,000. Everyone has a nil rate band allowance and, for those who wish to leave their home to their direct descendants, an additional Residence Nil Rate allowance.
For the current 2019/20 tax year, the total IHT allowances are therefore:
Nil Rate Band
Residence Nil Rate Band
The Residence Nil Rate Band is due to increase again in the 2020/21 tax year to £175,000.
Transfers on death between spouses or civil partners are completely free from tax. In these circumstances the first Nil Rate Band could potentially go unused, however any unused allowance can be transferred to the surviving spouse or civil partner and utilised in addition to their own allowances. Therefore on second death a combined allowance of up to £950,000 may be available (based on the current allowances).
Who is being caught by IHT?
For most people their main asset is their home or other residential property. Over the last 10 years (since the nil rate band was last increased) the average UK house price has risen by almost 50% from £154,452 in March 2009 to £228,147 in January 2019 according to the Land Registry House Price Index. In addition, we have seen many of our clients become private landlords or second property owners which will also increase their personal wealth. There are now over two million private landlords in the UK who let five million properties.
We are helping more and more clients to plan ahead to prepare for or reduce the IHT bill on their estate.
How can Origen help?
Gifts can be made to reduce the value of your estate and generally gifts up to £3,000 each year or regular gifts made from normal expenditure are exempt from IHT. Any of the unused annual £3,000 gift allowance can be carried forward to the next year.
Gifts over and above these allowances will be treated as Potentially Exempt Transfers (PETs) – which means that after seven years they will no longer be included in the value of your estate for Inheritance Tax. The rate of Inheritance Tax will reduce from three years after the date the gift was made until after seven years when it will no longer be subject to Inheritance Tax on the estate of the person who made the gift.
You can also consider gifting assets using a discretionary trust, which are treated as Chargeable Lifetime Transfers (CLTs) rather than PETs. Care should be taken with CLTs as there may be an immediate IHT charge if the value of the gift exceeds the available nil rate band. The interaction of PETS, CLTs and the Nil Rate Band is a complex area requiring advice to ensure that IHT is kept to a minimum.
It is important to note that any gift must be made without reservation. This means that you cannot gift something and continue to benefit from the asset, otherwise it will be included in the value of your estate on death.
We recommend that you should record details and information about any gifts you make including the date of the gift, who the gift was passed to, the value and any reliefs that may apply. This will help the executors of your estate who may need to complete forms IHT403 and IHT400 for HMRC. These forms are available from the Government website.
You can also set up a whole of life assurance policy which can provide a lump sum death benefit to meet the IHT due on your estate.
The IHT treatment of different assets is also a key part of planning. For example, you may consider taking income from your ISAs or other savings and leave more of your pension fund untouched, as a pension fund is generally outside your estate and therefore can pass to your beneficiaries free of IHT.
The benefits of gifting
Making gifts in your lifetime will reduce the value of your estate and the amount of IHT paid to the Government, meaning more of lifetime wealth can pass to your chosen beneficiaries on your death.
Lifetime gifting also means that you will see the enjoyment and benefits that these gifts can bring to your loved ones. There are a range of tax efficient gifting options, such as ISAs or pensions which can be very tax efficient ways to gift to children or grandchildren.
If you donate to charity in your Will, at least 10% of the value of your estate in excess of your IHT allowance, your estate will be subject to a reduced rate of IHT at 36%.
Whatever lifetime gifts you do plan to make, our advisers can advise you and recommend the best way to make gifts. However, you should always ensure that you have sufficient income to meet your living costs and also allow for potential additional costs which you may incur in later life.
There are several ways to manage your estate and we can discuss your own wishes and recommend the best solution for your circumstances.
CA4270 Exp 10/19