5 Great Ways to Minimize your Inheritance Tax (IHT)
At long last! A review of the Inheritance Tax (IHT)! You may have seen in the news recently that the Chancellor, Philip Hammond has written to the Office of Tax Simplification asking them to review the current IHT regime with a view to simplifying the complex and dated rules.
The current Inheritance Tax rules have been criticized for being complex and discriminatory. They are discriminatory towards unmarried couples, those without children and those who don’t own a property.
Interestingly, some countries have already abolished the so called “death tax”. Sweden was one of the first followed by Hong Kong and Russia. We doubt that will be the case here in UK but nonetheless, it will still be interesting to see what comes of this review. We will keep you updated on this, but in the meantime, here is an overview of the current IHT threshold.
The current Nil Rate Band (NRB) is £325,000 per person. You may also be able to benefit from the Residence Nil Rate Band (RNRB) if you own a property that is to pass to direct descendants. The RNRB came in to effect on the 6th April 2017 and started at £100,000. It will be rising yearly until 2020/21 when it reaches £175,000 . So, a married couple will be able to leave a joint estate of £1million without paying any IHT – as long as they make the best use of all their exemptions and allowances.
Unfortunately, unmarried couples cannot transfer the NRB and RNRB between them.
Let’s take a look at some great ways to minimise your IHT . . .
Ways to Minimize your Inheritance Tax (IHT)
YOUR WILL & YOUR SPOUSE
A vital element of effective estate planning is to make a Will. Unfortunately 60 per cent of adults with children under 18 fail to do so.
By making a Will you can ensure that your estate is distributed in accordance with your wishes.
This is particularly important if you have a spouse/civil partner because there is no IHT payable between spouses/civil partners . There could, however, be IHT payable if you die intestate and your estate ends up going to other relatives.
Frank passed away in 2012. He died intestate leaving a wife and three daughters. His wife, Moira, thought his estate was between £230,000 and £250,000 which was well below the NRB. However, as they looked through Frank’s papers it became evident that his estate was a lot more. He had been putting away money into various savings accounts and his estate was near £1million. A lot more than what his family initially thought it was. Because Frank died intestate, the law stated that his estate had to be distributed as follows:
- all the chattels passed to his wife;
- the first £250,000 of his estate his wife absolutely;
- his wife then got a life interest in the half of the remainder;
- and the other half went to his 3 daughters equally. Please note that these were the Intestacy Rules when Frank passed. The Intestacy Rules have since changed.
Frank’s daughters had to pay Inheritance Tax on their share of the estate as they were not exempt beneficiaries. This amounted to almost £150,000 but they managed to mitigate it completely.
How did they mitigate the IHT liability?
As it happens, Frank’s daughters wanted the entire estate to pass to their mother. They had a Deed of Variation drawn up, within the 2 year time frame, passing their shares over to their mother which completely mitigated the IHT liability.
With a correctly drafted will you can ensure that, on your death, your estate passes to your spouse/civil partner. This means that there will be no IHT to pay on first death. Bruce Forsyth did the the very same by leaving his entire estate to his wife. And, by doing this the full NRB and RNRB will be available to transfer on the second death.
To find out more about why you should have a correctly drafted will, please refer to our separate guide entitled “Why Do I Need a Will?”.
MAKE THE MOST OF YOUR LIFETIME GIFT ALLOWANCES
You can give cash or gifts worth up to £3,000 in total each tax year. These gifts are exempt from IHT when you die. Please note this is £3,000 per annum and not £3,000 per annum per recipient.
You can carry forward any unused part of the £3,000 exemption to the following year but then you must use it or lose it.
You can also make small gifts of up to £250 a year to as many people as you like.
GIFTS ON MARRIAGE
You can make larger than usual gifts on the marriage of a loved one without any IHT consequences. Parents can gift up to £5,000, grandparents £2,500 and anyone else can gift up to £1,000. These gifts do not use up any of your annual exemption. Such gifts are also discounted from the value of your estate for IHT purposes.
REGULAR GIFTS OUT OF SURPLUS INCOME
As well as putting lump sums into a trust you can also make monthly contributions into certain savings or insurance policies (not ISAs) and put them in trust.
The monthly contributions are potentially subject to IHT. But if you can prove that these payments are not compromising your standard of living (i.e. that you can afford the payments out of income and not out of capital) then they are exempt.
Likewise, any gifts of cash you make out of income are also exempt.
GIFTS TO EXEMPT BENEFICIARIES
Any gifts to your spouse are completely exempt from as IHT. As are gifts to political parties and charities.
Furthermore, if you leave at least 10% of your estate to charity, it will reduce the IHT rate on the rest of your estate. You will benefit from a reduced IHT rate of 36% rather than 40%.
This may not be a huge saving, but it can mean that family and friends will receive more than they would do otherwise – while your favourite charities also benefit.
POTENTIALLY EXEMPT TRANSFERS otherwise known as PETs
These are gifts to non-exempt beneficiaries and can potentially be exempt if you survive 7 years. If you die within 7 years of making a gift, it will be included in the value of your estate and may be subject to IHT.
If you put some of your assets into a trust (from which you, your spouse and your children do NOT have an absolute right to benefit), such assets are no longer part of your estate for IHT purposes.
You can set up a trust right away or you can establish one in your will. There may be Capital Gains Tax consequences if you transfer certain assets into a trust in your lifetime. There will be no liability to Capital Gains Tax if you establish a trust in your will.
Keep in mind that some types of trusts are subject to their own tax regimes. If the wrong type of trust is used it might have to pay IHT itself.
Also, trustees are likely to be liable for Income Tax at a rate of 45% on the trust income and Capital Gains tax at 28% on any capital gains in the trust.
The rules around trusts are complicated so you must take advice from an expert, such as Clarence Trustees.
You can use a Trust for the following purposes:
- Provide for vulnerable/disabled beneficiaries (Disabled Persons Trust)
- “Skip” a generation when passing assets (Spousal Bypass Trust)
- Simulate (for unmarried couples) the transfer of the NRB that is possible for married couples
To read about some of the trusts that can be used for IHT planning, please refer to our separate guide entitled “Trusts (an Introduction)”.
If you are not in a position to take avoiding action, an alternative approach is to make provision for paying IHT when it is due.
Your executors must ensure that any IHT that is due is paid within six months of your death. Otherwise HMRC start charging interest on the outstanding balance. Your executors can, in some circumstances, opt to pay the IHT by yearly instalments. The difficulty is that the Grant of Probate will not be issued until the IHT has been paid. Or at least till the first deposit has been paid, if your executors are paying by instalments. This means that your executors may have to either settle the IHT from their own pocket or they will need to take out a bridging loan. Usually, funds are not released from the estate until the Grant has been obtained. Although, some banks may settle the IHT bill.
This is where life assurance policies written in trust can be very useful. You can take out a life insurance policy in joint names (i.e. in your name together with your spouse/civil partner) with the policy only paying out on the second death.
The amount of cover should be equal to the expected IHT liability.
The benefits of putting a policy in trust
If you put your policy in trust then it will not form part of the estate. You can nominate your executors as the trustees, so that on your death the proceeds pay directly to them. They can then use proceeds to settle any IHT bill straightaway, without the need for bridging loans, etc.
But better than that, the premiums for such a policy will be paid by you, being the life insured which reduces the value of your estate. And, this subsequently reduces your IHT liability!
If your joint estate with your spouse/civil partner is up to £1million then the above will enable you to plan your estate so that no IHT becomes payable. However, if your joint estate is in excess of £1million then you may need to consider something extra . . .
FAMILY INVESTMENT VEHICLE
For estates over £1m with substantial investments, a Family Investment Vehicle (FIV) may well be appropriate. But this is in addition to and not instead of the preceding ideas.
A FIV is either a limited company or a limited liability partnership (LLP) combined (in some cases) with a family trust to provide a tax efficient vehicle in which to make long term investments where the assets can grow and/or earn income in a lower tax environment.
A Family Investment Vehicle is usually created to protect your “family wealth” and if structured correctly, it can save you significant amounts in IHT. As such, they allow your wealth to provide long term benefits to your children and grandchildren.
You can retain control over the family wealth until you pass away. At that point the next generation can take control.
If your estate is of this magnitude, please contact Clarence Trustees for advice on a FIV.
HOW WE CAN HELP
Clarence Trustees can provide a complete estate planning service.
- Draft your will to ensure you make use of all your available exemptions and allowances;
- Advise on and implement any trusts that may be necessary;
- Assist with the protection of your assets; and
- Provide extended IHT planning (such as FIVs) for higher value estates.
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