With HMRC taking a massive £7.1 billion in receipts from Inheritance Tax (IHT) in 2022/23, is now the time to consider your options for passing on wealth efficiently?
Receipts from IHT were up £1 billion compared to the same period in 2021/22, largely due to more estates being dragged into the IHT net. This is especially true for those who own property in London and the south-east.
As Jeremy Hunt has frozen the IHT threshold at £325,000 until 2028, it is likely to push even more estates into the IHT net in the coming years.
So, is now the time to start considering options to help mitigate some of this tax in the future?
When do you pay IHT?
Everyone has a £325,000 IHT nil-rate band. If you are married or in a civil partnership, you and your spouse have a combined nil-rate band of £650,000.
From April 2017, an additional main “residence nil-rate band” was introduced. For the 2023/24 tax year, the individual allowance remains at £175,000. To qualify, the individual’s main residence must be passed down to a direct lineal descendant.
Additional rules around the residence nil-rate band also apply, for example, if a person’s estate value exceeds £2 million, the residence nil-rate band is reduced by £1 for every £2 over £2 million. Anyone with an estate valued in excess of £2.35 million will not be able to benefit from this additional main residence allowance.
Here’s an example.
An individual estate is valued at £1 million. Assuming that only one nil-rate band is available, and no residence nil-rate band is available, the outcome is below:
£1,000,000 – £325,000 (nil-rate band) = £675,000
£675,000 x 40% (IHT rate) = £270,000
Can you afford to give assets away?
One of the most important questions that you need to address before even considering IHT mitigation options, is: “Is it affordable?”
It’s crucial to work out in advance whether you’re likely to need your money in the future – because once you give it away, you may not be able to get your hands on it again.
Financial planners, therefore, suggest that people thinking of giving away wealth conduct a thorough cashflow forecasting exercise to work out as best as possible what their assets and liabilities – and income and expenditure – could be in the future. This in turn will provide a picture of what their future financial position could look like.
But does it have to be an all-or-nothing approach?
The gifting basics
The simplest way to give away wealth is to make an outright gift. Gifts made to other individuals are generally not subject to IHT unless the person making the gift dies within seven years.
You can also use the annual gift allowance of up to £3,000 (2023/24 tax year), and this will not be subject to IHT even if death does occur within seven years. This can also be backdated one tax year if not previously used. Therefore, a couple could gift up to £12,000 away using this allowance and not be liable for any future IHT.
Over and above this allowance, any outright gift would be classified as a “potentially exempt transfer” (PET) with the requirement of living for seven years before it falls outside of an estate.
Many people have concerns about control and protection when passing on wealth to the next generation. This might be in the form of controlling who benefits and when, or simply retaining some level of access to the capital.
The use of a trust may be suitable and there are numerous types of trusts which vary in terms of flexibility, access, control, and tax efficiency. Generally speaking, the more flexibility, access and control you require, the less tax-efficient a trust may be in terms of mitigating IHT.
However, trusts can be a very useful tool to use when considering IHT mitigation. Here are three that could be particularly beneficial.
1. A gift and loan trust
A gift and loan trust is one of the simpler trust structures to help mitigate IHT.
In essence, the settlor loans money to the trust. The trustees then invest this money for the benefit of the trust beneficiaries. As the settlor has made a loan into the trust, they can demand repayment of this loan at any time, either in part or in full.
However, any fund growth is considered outside of the estate for IHT purposes and must be used for the benefit of the beneficiaries. Additionally, if it is decided that no more access is required, the settlor can give up the right to some or all the loan.
A gift and loan trust is suitable for those who cannot afford to gift away a capital sum but want to limit any future growth in the value of their estate.
2. A flexible reversionary trust
A flexible reversionary trust is a very effective way to save on future IHT but retain some level of access.
Capital is placed into the trust and split into several policies which mature in different years. This allows a level of access to be retained and, when these policies mature, there is the option to receive capital back.
If capital is not required, you can forego the option to take it and add it to a policy year in the future. Once capital has been held in the trust for seven years, this will fall outside of an estate for IHT purposes.
A discretionary trust is used for a reversionary trust, therefore care needs to be taken when choosing an amount of capital to place into the trust.
This type of trust is suitable for those who are likely to live longer than a seven-year period, may potentially need access to some level of capital in the future and wish to maintain an element of control over who eventually benefits.
3. A discounted gift trust
A discounted gift trust is an excellent way of making a gift for IHT purposes whilst retaining a regular income payment for life.
Capital is placed into the arrangement and an amount is immediately discounted for IHT purposes. This discount is generally decided through a calculation performed by an insurance company and is based on factors such as health, age and the level of payments required.
The arrangement becomes highly effective for IHT planning as the discounted amount is outside of an estate immediately, with the remainder fully outside of an estate after seven years.
However, when setting up a discounted gift trust, it is essential to determine the level of any income payments, as once this has been set, it is irrevocable and therefore cannot be changed in the future.
This type of trust is suitable for those who need regular payments to supplement their other income but would like to reduce their IHT liability immediately.
Some other IHT planning options
Whilst the above provides an insight into some of the estate planning options available, there are very effective alternatives.
- Gifts out of excess income
- Business Relief investments
- Whole of life cover
- A “gift inter vivos” policy
- Family investment companies.
With so many options available, it can be overwhelming to decide which one to choose. However, discussing your circumstances and future intentions with a financial planner can make a difference.
At HFMC, we can assist you in finding suitable estate planning solutions for your financial circumstances, to reduce the tax liability for your beneficiaries.
Should you wish to discuss your options and how we can assist you, please get in touch.