Mitigating Inheritance Tax without gifting wealth
Bereft families paid £5.2 billion in Inheritance Tax (IHT) in 2017/18, an 8% increase from £4.9 billion in the previous year. In fact, that’s the highest amount raised since IHT was introduced, figures from the Office for National Statistics show.
The tax revenue has been increasing steadily year-on-year since 2010/11, largely thanks to stagnant tax thresholds and increasing estate values. This is especially true in the South East, where property prices have risen significantly over the same timeframe.
First, let’s remind ourselves how the 40% tax works. There are two thresholds, up to which IHT is exempt:
- The Nil-Rate Band is £325,000 and has been since 2009. It is planned to remain at this level until 2020/2021.
- The Residence Nil-Rate Band is currently £125,000. It is planned to increase £25,000 p.a. up to a maximum of £175,000 in 2020/21.
Effectively then, the tax-free threshold is currently £450,000 per person. If you are married or in a civil partnership, when the first spouse dies their unused allowance can be passed on. This would give the surviving person a total exemption of up to £900,000.
But, it’s not quite as simple as that. If your total estate is valued at over £2 million, the Residence Nil-Rate Band (RNRB) is tapered away by £1 for every £2 above £2 million. As a result, when the RNRB does reach £175,000 in 2020/21, anyone with an estate worth over £2.35 million will not benefit from it.
The big question, however; why is IHT revenue continuing to increase, despite planning opportunities available to reduce or completely avoid the liability? Unfortunately, it will either be a lack of information or forward planning. So, we are here to help.
One of the most frequently used methods to avoid IHT is to make gifts to loved ones during your lifetime. But what if you want to retain your personal wealth? Here are eight ways to mitigate IHT without giving cash or assets away:
1. Ensure you have a valid, up-to-date will
The absolute first thing to address is your will. Amazingly, according to Unbiased, 60% of UK adults don’t have one at all. Dying without one means you die ‘intestate’ and you have zero control over your wealth’s distribution, which is likely to be incredibly inefficient considering IHT.
If you have a will, check it’s still appropriate and up-to-date. Your circumstances are likely to have changed if it was put in place some time ago, or if you’ve experienced a big life event, like having children, since.
2. Maximising pension contributions
Pensions are often exempt from IHT and would not form part of your estate. If you die before you reach 75, a Money Purchase Pension can be paid as a lump sum or regular income completely free of any tax. If you die after age 75, your beneficiary will need to pay Income Tax, but still no IHT. As with your will, ensure the pension Death Benefit nomination is up-to-date and remains relevant.
The Lifetime Allowance, the maximum you can tax-efficiently save in pension schemes, is currently just £1.03 million. You may exceed this relatively quickly and additional tax would be liable. It’s prudent at this point to maximise other tax-efficient saving vehicles, such as ISAs, which, whilst not completely exempt, can be passed to a spouse free of IHT. If you are concerned about exceeding the Lifetime Allowance and your retirement planning options, do get in touch.
3. Structure your property ownership
By owning your home as joint tenants, if your partner dies you automatically become the sole owner. It may make more sense to be ‘tenants in common’. This means you each own a defined percentage of the property. You are then able to pass your share on to your children, for example, potentially helping to reduce an IHT bill.
4. Utilise Business Relief
Investments, businesses and some of their assets held for two years may qualify for Business Relief and can be passed on free from some, or all, IHT. If you own a business or a share in an unlisted company, they can be eligible for 100% relief. Business land, buildings or machinery can qualify for 50% relief.
‘Unlisted’ shares that qualify for 100% Business Relief include some shares listed on the Alternative Investment Market (AIM). For this reason, there are specialist IHT exempt AIM investment portfolios available. There are strict rules around which AIM stocks qualify, and some investments can carry higher levels of risk. We would always recommend talking to a professional financial planner if you’d like to explore this opportunity in greater detail.
5. Insuring against the liability
If you are unable to completely mitigate a potential IHT bill, a Life Insurance policy can help family meet or reduce it. The policy would need to be written in trust, to pay out to a named person or people, otherwise, it would be added to your estate and actually increase an IHT liability.
6. Use a Discounted Gift Trust
A Discounted Gift Trust lets you gift money to a trust for your beneficiaries, meaning it’s exempt from IHT after 7 years, but you are also able to retain the right to draw regular income from it. The initial gift may also be discounted offering the potential to immediately reduce your Inheritance Tax liability. They are inflexible once set up though, and there are particular rules to adhere to, so they do tend to be a part of a wider inheritance tax planning strategy. There are also other simple Trusts, such as a Loan Trusts, that can be considered.
7. Loan Trust
A Loan Trust allows you to loan capital to a trust for your beneficiaries. You can access the original capital sum loaned at any time, either as a full lump sum, occasional sum or regular repayments of the loan, addressing any concerns about unforeseen circumstances. Any growth on the investment is part of the trust and therefore will not further increase the size of your estate. You can choose for the loan to be waived on death, meaning that the trustees can access the money immediately. This is frequently used in combination with Life Assurance and a Discounted Gift Trust.
8. Set up a Family Investment Company
As an alternative to a Discounted Gift Trust, a Family Investment Company (FIC) is a UK-resident private limited company whose shareholders are all family members. They enable you to pass wealth to other family members whilst retaining control of your wealth. You could fund an FIC in the form of interest-free loans, or by subscribing for preference shares. This will not be regarded as a transfer of value for IHT purposes. Funds can then be withdrawn from the company at a later date, tax-free. This is typically only suitable for multi-million pound estates.
If you’d like to discuss ways of minimising or potentially eliminating your likely Inheritance Tax bill, our boutique wealth planners are able to assist you. Please don’t hesitate to get in touch.