Nick Frank
Private Client Director
When I work with clients, one of their overriding concerns is often “how can I reduce the amount of Inheritance Tax (IHT) my heirs will have to pay when I pass away?”
Official government figures reveal that the IHT burden on families is rising, with estates paying £3.9 billion in IHT between April and September 2023 – up £0.4 billion on the same period a year earlier.
You may have recently read about some strategies for reducing an IHT burden. And, of course, gifting can be a great option for some – provided you live for seven years after making any gift.
But what if you, or an older relative haven’t made any plans and need to try and reduce an IHT liability later in life? If you or they are unlikely to live for a further seven years, gifting may not solve the problem, as the value of the gifts will remain part of your estate.
Here are two practical options to consider.
1. Business Relief investments
Business Relief (BR) was introduced as part of the 1976 Finance Act to allow small businesses to be passed down through generations without facing a large IHT bill.
These days, BR can be a valuable relief from tax even for people who don’t own their own business, as by using specific investments it can allow you to leave more of your estate to your beneficiaries free from IHT.
These investments are typically in smaller, start-up businesses – for example, unquoted firms or those listed on the Alternative Investment Market (AIM).
While there can be additional risks involved in investing in smaller, less established firms, and the investment can be harder to sell than those listed on larger stock markets, the tax incentives can sometimes compensate for this.
For example, while making a gift or putting assets in trust means it will usually take seven years before they become exempt from IHT, shares in a BR-qualifying company or investment usually becomes exempt from IHT after being held for just two years, as long as you still hold the shares at the time of death.
Moreover, unlike a gift or a trust, you retain control over the investment, and you can sell it and retain the proceeds should you need to (although, if you do this, any money you take out of the investment is no longer exempt from IHT).
There are companies that specialise in creating portfolios of BR-qualifying investments, and this process can sometimes be simpler when compared to the potential administrative complexities of setting up a trust or using life insurance.
As you only have to hold these investments for two years to qualify for relief, and hold them at the time of your passing, they can be a useful planning tool later in life. Further, it is possible to change the specific BR-qualifying assets without restarting the two-year clock. Passing BR-qualifying investments to heirs on your death can exclude them from IHT calculations, meaning they retain more of your wealth.
Please note that as these solutions are higher risk investments, they are not suitable for all circumstances, and as such, we would strongly recommend seeking personal advice from your financial planner if you would like to consider this option.
Gifting at the end of life
As you may have read, early planning can help you to make the most of the IHT reliefs available. Making arrangements for wealth transfer can enable you take advantage of gifting exemptions, trusts and the “seven-year rule”, helping you to proactively mitigate a bill.
However, if you or an elderly relative has made no plans, there are still steps you or they can take even if they are at the very end of life.
In addition to the individual “nil-rate band” of £325,000, individuals can also benefit from the “residence nil-rate band”. This means you can gain an additional £175,000 of IHT relief per person if you pass your main residence to a child or grandchild.
Married couples can inherit unused nil rate allowances from their partners, therefore you can potentially have up to £1,000,000 in allowances in total.
However, if your estate is valued at more than £2 million, you lose £1 of the residence nil-rate band for every £2 of value. If the total value of the estate is more than £2.35 million, you’ll lose this additional relief entirely.
However, there is a way that you can reclaim your residence nil-rate band, even late in life.
The £2 million threshold is based on a simple calculation that is effectively “assets less liabilities”. Interestingly, the £2 million calculation does not add back in gifts made within seven years – even if these might be considered when calculating the IHT bill itself. The gifts themselves would be classed as a failed Potentially Exempt Transfer (PET).
Not including these gifts in the calculation creates a solution to the £2 million taper threshold.
If your estate is valued above £2 million, you could consider making a gift to reduce the overall value of the estate to below £2 million. As long as the gift means your estate ends up below £2 million, up to a full £350,000 (for married couples when the second person dies) residence nil-rate band will apply.
Crucially, it does not matter when this gift is made. It could be the day, the week, or the month before your death. The only thing that matters is that, on the date of death, the “assets less liabilities” calculation gives an outcome of less than £2 million.
The gift would still likely be included in the tax calculations and liable for IHT, but you would retain your full nil-rate bands.
Get in touch
Careful planning can help you and your loved ones to mitigate a potential IHT bill.
To find out more about how a financial planner could help you to leave more of your wealth to loved ones, please get in touch. Contact us online, or call 020 7400 4700.
