By Carl Drummond, Wealth Planner
Most people accept that tax is a fact of life, and that while there might be ways to minimise it, the more you earn, the more you owe. But when it comes to Inheritance Tax (IHT), many clients feel a sense of injustice. After all, they’ve dutifully paid their taxes, and diligently saved so as not to be a burden on the state. Why then does the tax man take another 40 per cent of their estate when they die?
With careful planning, there are ways to minimise your IHT liability, but first you must understand the rules:
By 2020/21, you will be able to pass down up to £1,000,000 free from IHT. Here’s how:
Nil-rate band - The first £325,000 of your total estate can be passed down to your beneficiaries free from IHT. If you are married, then you each have this allowance. When the first person dies, their allowance is passed to their spouse, which means they can pass down £650,000 free from IHT.
Residence nil-rate band - In addition, there is a new allowance for passing down property, if that property is your main residence. This is known as the ‘residence nil-rate band’. For this tax year (2018/19), property owners will be able to pass down an additional £125,000 (£250,000 for couples) of the value of their main residence, meaning they could have a total individual allowance of £450,000, or £900,000 for couples. By 2020/21, this new allowance rises to £175,000, so a total individual allowance of £500,000, or £1 million for couples.
If, however your estate is worth over £2,000,000, the tax man starts taking this allowance away. You lose £1 of allowance for every £2 of value above £2 million. So, if your property is worth £2,350,000 or more, you will get no additional allowance.
So, what about the rest?
If you’re lucky enough to have an estate worth more than £1 million (£500,000 if you’re on your own), then the rest is liable to be taxed at 40% when you die. But there are ways to minimise this:
You can give away £3,000 a year IHT free. If you don’t make that gift in one tax year, you can carry it over to the following tax year, but for one year only.
In addition, you can give away £250 to as many people as you wish in a given tax year.
A wedding gift is IHT free. You can give up to £5,000 as a parent, £2,500 as a grandparent, and £1,000 to anyone else.
You can donate as much as you like to charity and it will not incur IHT.
You can gift as much as you like over and above these thresholds, but if you die within seven years the beneficiary may pay IHT on the gift.
Can I protect my remaining assets from IHT?
There are ways to protect your remaining assets from IHT, but this is very specialist and you should always seek advice from a trusted adviser before embarking on any of the strategies below:
Put assets into trust - By putting assets into trust, you can normally no longer benefit from them, and therefore it doesn’t count towards your IHT bill. There are various types of trust, but they all have the same basic premise – they have a trustee who manages the trust, and a beneficiary who will ultimately receive the assets, according to the rules you set out when you set it up.
Take out life insurance - Many clients worry about leaving a large IHT bill to their family, which must be paid within six months of your death. It is possible to take out a life insurance policy which will pay this IHT bill, assuming it is held within a trust and doesn’t form part of your estate.
Spend it now - There is a deeply entrenched belief in this country that you must leave as much money as possible to your family when you die. But why shouldn’t you enjoy some of your hard-earned money while you can? If your biggest asset is your home, you could think about releasing some of the equity to enjoy, or pass on, now. This could ultimately reduce your IHT bill, while putting the money to good use when it’s really needed.Be aware of the seven-year rule though if you intend to gift this to family.
Invest in a specialist fund - Sanlam has a fund that invests in shares listed on the Alternative Investment Market (AIM). This index is made up of smaller companies that are seeking to expand, and investment in such businesses is exempt from IHT after two years through Business Property Relief. This is a riskier investment strategy by the very nature of the businesses within the index, but it can be a good way to protect your investment from IHT, if you’re comfortable with potential losses.
There are various ways to minimise your IHT liability. My advice to clients is to start thinking about this now. The earlier you start planning for it, the more money you will save. If you think your estate will be worth significantly more than £1,000,000 as a couple, or £500,000 as an individual, then you should speak to an adviser about your options. It’s never a good idea to leave these things to chance.
The content of this article is based on our understanding of HMRC practice as at February 2019. Tax rules are subject to change.