7 April 2022

Life & Legacy Blog - Part 2: Legacy, and reducing Inheritance Tax

Many of our clients are several years into retirement and now one of their biggest financial challenges is not building funds, but reducing how much tax is likely to be paid on their ultimate death to maximise what is passed on and/or they are considering gifting money to individuals or causes who need it now, at a time when our clients can enjoy seeing the benefits of these gifts.

Views vary, but most of us want to take at least some sensible simple actions to reduce the likely Inheritance Tax (IHT) bill on death and, in so doing, increase the amount passed to our beneficiaries.

To recap, IHT is paid at 40% of the value of your estate after certain allowances and exemptions.

On death each individual has a ‘nil rate band’, an amount that they can pass on without any IHT, and that band is currently £325,000. In addition to this, and subject to meeting certain criteria, one of which is that your total estate is worth £2m or less, you are entitled to an additional ‘residence nil rate band’ of £175,000, designed to give your estate some relief from the effects of house price inflation. Therefore, individuals with estates of £2m or less have a potential allowance of £500,000, couples £1m combined.

So, if you are a couple with an estate of £2m, including a house, you would normally have combined nil-rate bands of £1m, leaving a taxable estate of £1m. This would mean IHT payable of £400k and an estate of £1.6m that could be split between beneficiaries.

There are a range of reliefs and exemptions including the annual £3,000 gift allowance (this is a total and not an allowance per recipient as is sometimes thought), gifts on marriage, and regular gifts out of income.

Beyond the annual gift allowance, perhaps the most commonly-used relief is the ‘potentially exemption transfer’ or ‘PET’. This allows an individual to give away an unlimited amount and, as long as the donor survives the date of the gift by seven years, the gift is exempt from IHT. However, should the donor die within the seven year period, the value, or part thereof (there is a sliding scale, but note this is a point often overlooked, this sliding scale only applies where the gift is more than the ‘nil-rate band’ of £325,000), is added back into the donor’s estate for the purposes of calculating IHT. If a donor is confident they are able to give away a certain amount, from an IHT perspective there is little downside in doing so, as, if they don’t make the gift the value is in their estate, and if they make the gift it may fall out of their estate, if the donor lives long enough.

A variant on the PET is a gift into trust, and here, generally speaking, an amount up to the ‘nil-rate band’ (currently £325,000) is exempt and no tax is payable on the transfer. Amounts in excess of this are subject to a lifetime tax of 20% and, potentially, if the donor dies within seven years of making the gift, a further 20%. Because of this lifetime charge of 20%, gifts to trust tend to be limited to £325,000, or £650,000 per couple, although they can be made every seven years i.e. over a 21 year period you can give away four lots of £325,000 (at year 0, year 7, year 14 and year 21).

Beyond the reliefs and exemptions noted above, there are some more specialised structures that individuals can consider, including certain investments such as AiM-listed shares or companies attracting Business Relief.

For those individuals with liquid assets of several million, a family investment company can offer attractions. There are also some options based around life assurance bonds which aim to give some reduction to IHT while allowing a degree of access to the funds.

Of course, there is a get out clause from paying any IHT, and that is to direct your estate to charity, as no tax is payable on gifts to registered charities. And, indeed, making gifts to causes that are close our clients’ hearts is something we talk about and are keen that clients consider during their lifetimes so they can enjoy seeing the benefits of the gift.

At the very least, if you direct 10% of your estate to charity on death (and it’s not quite as straightforward as that, but that’s the concept), you can reduce your IHT rate on the balance of your estate from 40% to 36%.

So, if charitable giving is part of your overall plan, it is worth considering how you are approaching this and determining if there is a better way to do it, to the benefit of the charity and possibly your other beneficiaries.

How much?

Keeping thing simple and just gifting money is always our starting point, but the bigger question is, of course, how much to give away? And the answer is to work out how much you need for the rest of your life, and give away the balance.

Simple, except it isn’t of course, and in the next blog we’ll look at this in more detail.

The value of investments and the income derived from them can fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. It represents our understanding of law and HM Revenue & Customs practice. You are recommended to seek competent professional advice before taking any action. Tax and Estate Planning Services are not regulated by the Financial Conduct Authority.

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