On death, the total value of an individual’s estate (less available reliefs) becomes liable for IHT at 40%. This includes everything you own e.g. your home, all assets in your own name, together with any other assets you may have an interest in, and potentially gifts made in the seven years prior to death.
The tax applies to the UK domiciled (and deemed domiciled) individuals and is charged on worldwide assets, with non-domiciled individuals only subject to IHT on assets situated in the UK.
However, there is some good news. Every individual has what is called the “Nil Rate Band” (NRB), which currently stands at £325k, in simple terms this allows an individual to pass their estate, up to this value free of any IHT. Married couples and registered civil partners can transfer any unused NRB, when the first person dies, to the survivor. Potentially providing a total NRB of £650k.
In addition to the NRB, there is also the Residential Nil Rate Band (RNRB), which currently stands at £175k. This additional allowance is used when your residence is inherited by a direct descendant (including step, adopted or fostered children). Like the NRB, unused RNRB can also be transferred to the spouse/partner on the first death.
Combining the above allowances, an individual can pass on a total of £500k with an IHT liability, and a couple can pass £1m in total. However, it is important to also note that the RNRB is removed, on a tapered basis, once an individual’s estate exceeds £2m.
In 2020/21, IHT raised in excess of £5bn, which is the 2nd highest amount since it was first introduced, and more than double the annual amount paid in IHT in the 2009/10 tax year. This increase can be attributed to increases in property and liquid wealth in an ageing population, and to IHT legislation that has remained broadly unchanged, save the introduction of the RNRB, for a long time now.
Despite this, IHT is still often described as the “optional tax” reflecting the fact that there are numerous planning options available to those who wish to try to reduce their potential IHT liability. As a result, the government is currently consulting on wide-reaching changes in IHT legislation with the general expectation that the number of planning options and/or the efficacy of that planning will reduce over the coming years.
Fortunately, there is still a wide range of planning options available to reduce potential IHT liabilities, with many people either not aware of these options, or simply failing to take full advantage of them.
Exempt Gifting
Undoubtedly the most straightforward and effective option, but also often the most under-used and misunderstood. Certain gifts fall immediately outside of the donor’s estate and are exempt from IHT without the need for the donor to live the usual seven years.
A number of gifts fall into this category; wedding gifts to children, grandchildren and other individuals; gifts of up to £250 per individual, gifts of up to £3,000 per annum; gifts to institutions such as charities, universities and museums. There is also an unlimited exemption for gifting away surplus income, and this can have a significant impact on an estate if the principles are applied correctly over a prolonged period.
There are of course rules associated with each of these exemptions and we would recommend you take advice to work out which apply to your circumstances and objectives.
Non-Exempt Gifting
This category covers any gifts that do not fall within one of the exemptions. In almost all instances, these gifts require the donor to live for seven years for them to be fully effective for IHT purposes, so planning ahead is important.
Other Trust Planning
A big challenge for many people in forming an IHT strategy is having confidence that they can irrevocably give money away. The uncertain and ever-rising cost of care often leaves people concerned about such gifts.
A potential solution in these scenarios is to consider types of trust that succeed in removing assets from the estate but then provide access, in different forms, to those assets if they are needed in the future.
Pensions
Pension funds are usually held in trust and therefore do not sit within the taxable estate and are not subject to IHT on death.
We, therefore encourage people to maximise their pension funds where possible, subject to Annual Allowance and Lifetime Allowance considerations and also encourage them to consider their reliance on their pension funds in retirement (i.e. could they draw on other assets that are less IHT-efficient and preserve the pension funds that already fall outside of their estate).
Insurance
There is a neatness to using insurance in the IHT planning process – the IHT liability occurs at the point of death, and life insurance pays out a lump sum at the same point in time.
We often use insurance contracts to cover both short-term IHT liabilities (i.e. where a person needs to live seven years for a gift to be “successful” for IHT purposes) and long-term liabilities (i.e. an underlying IHT liability that cannot be mitigated with lifetime planning and therefore liquidity needs to be created by way of insurance).
Exempt assets
Business Relief (BR) is a specific tax treatment that applies to holdings in smaller businesses and it generally means that, once the asset has been held for two years, it is exempt from IHT. This is good news for people who own family businesses (where those businesses qualify) as it means that the business can pass down to future generations without 40% of its value being paid to HMRC. However, for those individuals without family businesses, BR relief can still be obtained by making certain qualifying investments.
Whilst these are effective options, they should be carefully considered as they are classed as very high-risk investments and require specialist advice.
Our advisers will work with you to understand your current position and identify which of the above options merit consideration given your specific circumstances. We can then help you create a personalised strategy, which we would review on an ongoing basis to account for future changes in your circumstances and in tax legislation.
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