Your Money not the Taxman

There’s a lot written about inheritance tax (IHT) planning and much of it is useful and reasonable. There are clever schemes that involve gifting money to special types of trust, investing in particular share classes that qualify for certain reliefs, more complicated products from life companies that appear to let you save IHT yet still enjoy your money and a plethora of different trust arrangements available directly from Solicitors. However, although these schemes work, before you engage in them you should firstly consider more simple solutions, some of which I have set out below.

Before you take any advice from any professional you should first think about what it is you want to achieve. In my experience much of the IHT planning advice is given in isolation from the rest of the clients affairs and it may well achieve a tax saving, but at what cost to the rest of the clients financial plan. The problem is that many professionals advising clients see the saving of tax as an easy ‘sell’ to clients and this often leads to the tax tail wagging the dog. It may be possible to save IHT for the next generation, but if that doesn’t leave you with enough money to enjoy your life what’s the point?

Get a Will!

The starting point of any estate planning is the Will and our recommendation would be that this document should be drafted by a professional and not a DIY kit from a high street store. Its job is to create certainty in terms of where you want your money to end up, and secondly to ensure that the correct tax reliefs availed to you can be claimed if required.

How much is Inheritance Tax?

There are fundamentally two rates of IHT, 0% on any assets that are within your allowance and 40% on anything above that. Other tapered rates for gifts made within seven years of death can apply, and also a rate of 20% on gifts to certain Trusts above a certain amount but I’m not going to deal with them here for the sake of brevity.

Simple solutions

In practical terms saving inheritance tax is very easy, the simplest solution is just to spend your money on your lifestyle such that when you die your estate isn’t big enough to warrant a tax liability. Remember, there are no prizes for being the richest man in the graveyard.

This approach, however, isn’t very popular with the professional advisers as it doesn’t lead to any investment product being sold or legal document being drafted.

So how much can you leave without a liability to IHT?

Assuming you haven’t made any gifts above £3,000 in the previous seven years, married partners or those in a Civil Partnership can leave an estate of £325,000 each (the Nil rate Band (NRB)) so a total of £650,000 between them. In addition to this, following April’s introduction of the Residential Nil Rate Band (RNRB), each party can also gift an additional £125,000 (which will rise to £175,000 by 2020) so long as this additional allowance pertains only to the main residence and the residence is inherited by direct lineal descendants.

Thus, at present a couple who are married or in a Civil Partnership can pass (with their wills correctly drafted) £900,000 to the next generation without any IHT, and from April 2021 this will be £1,000,000 so long as the Main residence is worth at least £350,000. A single person can therefore currently gift £450,000 rising to £500,000 in 2021. Not a bad start.

But what if you have wealth above this amount and don’t want to pay 40% IHT on it?

The second most straightforward solution is simply to gift the money away at least seven years prior to you dying. In its most straightforward form this can be done by a ‘Potentially Exempt Transfer’ (PET) which is literally just someone transferring money to another person. Once the gift is made, so long as the donor survives seven years there is no IHT payable on the gift. Thus the first stage is to work out how much you can afford to gift. This is done through good financial planning and the construction of a lifestyle cash flow which will identity how much of your money you are going to need and how much you are never likely to spend and can thus afford to gift.

Once you have decided that you can afford to make a gift, this can be made directly to your beneficiaries or if you are worried about then squandering the money (or they are below the age of 18), you could use a trust. A trust will allow you to retain control over the assets while you are still alive and also benefit subsequent generations. They are very useful tools and favoured by Solicitor’s, but are also more complex and are more costly to administrate.

If you don’t want to gift money away, but don’t want to spend it either, then the final solution would be to insure the tax liability with a life assurance plan. To do this your Financial Planner can work with you to identify how big the tax bill will be on your death and you buy a life policy that pays out an amount equal to the liability to a trust. The beneficiaries of the trust are the people you wish to inherit your estate and so they use the proceeds from the life plan to pay the tax bill. It is a very simple solution to the problem but can prove very costly long term as the premiums on the life plan will rise very sharply as you get older.

Other options

You can gift free of IHT up to £3,000 pa each to a beneficiary/ies without it effecting your allowances above or being treated as a PET, so no seven year clock ticking. A couple could therefore gift £6,000 pa.

In addition to the above, if you have a regular form of income (such as pension income) and this income exceeds your regular normal expenditure then you can also gift the difference between the two figures. Thus, if your income was £40,000 pa after tax and your regular expenditure was only £30,000, you could gift £10,000 from income as well as £3,000 each from capital as a married couple or Civil Partnership. The key here is to keep careful records to prove to HMRC that these gifts from income were genuine and sustainable and not from capital.

Charitable giving

Finally, even if you do die with assets in excess of your allowances the easiest way to reduce or remove your IHT liability is to gift anything over the allowances to charity. These gifts will pass free of IHT to the named charities and no IHT will be chargeable. If you don’t want to gift that much and your estate will still be above your allowances then you can reduce the IHT rate of 40% to 36%, on the balance of your estate above the allowances by ensuring at least 10% of your total estate is gifted to charity.

We have just scratched the surface in this article as there are many other approaches you could take, but all carry increasing levels of complexity and risk. However, the fundamentals don’t change and you should consider the following:

  • Your lifestyle and wellbeing should be put ahead of saving tax, don’t let the tax tail wag the dog.
  • The easiest way to avoid IHT is not to die with assets over your allowances so spend it on your lifestyle. Remember, money has no value unless it’s changing hands.
  •  Be aware that more complex solutions, such as trusts, will involve greater administrative burdens and costs.
  • You can gift any amount of money away, directly to beneficiaries without any immediate liability to IHT and so long as you survive seven years no tax will be payable on the gift.
  • You can gift to a trust if you’re concerned about maintaining control of the money.
  • You could insure the problem with a life assurance plan.
  • You could make use of your annual allowance of £3,000 each and gift from income if your income is greater than your expenditure.
  • You can use philanthropy as a planning tool by gifting assets to charities on death.
  •  There are other more complex investment based options that we can consider within the context of your financial plan if the above more simple options don’t meet your needs.

Nick Crabbe

Financial Planner & Director