Tony Granger examines different ways to reduce the incidence of inheritance tax payable on an individual’s estate.
Inheritance tax (IHT) is payable at 40% on the taxable value of an individual’s estate on death, after all deductions, exemptions, etc. are taken into account.
If chargeable lifetime gifts are made (usually gifts into a discretionary trust), any amount above the unused portion of the IHT ‘nil rate band’ (currently £325,000) is taxed at 20%. In this way, IHT can be payable upfront whilst still alive.
The government currently raises £5.4 billion from IHT receipts (in 2020/21), expected to rise to £6.3 billion in 2023/24.
Personal strategies to reduce IHT
These measures can reduce an individual’s estate and save IHT; assets passing to a spouse or civil partner are generally exempt.
1. Making gifts to others
You can make a gift of any amount to anyone; so long as the donor survives for at least seven years, that gifted value is outside the donor’s estate.
There is an annual gift exemption of £3,000 per annum; a small gift exemption of £250 to any person each year (irrespective of the number of people); and gifts in consideration of marriage (or civil partnership) of £5,000 per parent, £2,500 by a grandparent, and £1,000 by anyone else.
Spouses and civil partners can generally make exempt gifts of any amount to each other (and the other spouse can then make onward gifts). Gifts for the maintenance of a spouse or child are not subject to IHT if certain conditions are satisfied. Payments representing normal expenditure out of income are exempt.
2. Making gifts to trusts
Gifts into trust up to £325,000 are free of IHT. Assets building value inside the trust will be exempt from IHT an individual’s estate unless the gift was a ‘gift with reservation of benefit’.
Life assurance written in trust is generally exempt. Pension funds are also generally IHT exempt within certain limits.
3. Making gifts to charity
Assets left to charities are generally exempt for IHT purposes.
A donor can also cut the IHT rate on the rest of their estate from 40% to 36% if at least 10% of the donor’s 'net estate' is left to a charity.
Use of nil rate bands
Each person has a ‘nil rate band’ (i.e. effectively IHT at a rate of 0%) (i.e. currently £325,000).
In addition, if an individual’s present or former residence is left to a direct descendant in 2019/20, there is an additional ‘residence nil rate band’ of £150,000 (or £175,000 from 6 April 2020). Planning around the family home can save significant IHT.
The ‘standard’ and residence nil rate bands can potentially be transferred to a spouse or civil partner if not used.
Investments that reduce IHT
Enterprise investment scheme and seed enterprise investment scheme investments held for at least two years are generally eligible for business property relief (BPR), including certain alternative investment market shares. Woodlands investments can attract BPR at 100%. Assets that have BPR and agricultural property relief attaching, such as farms, are relieved at up to 100%.
A discounted portion of a ‘discounted gift trust’ investment can be immediately outside an individual’s estate.
Business strategies to reduce IHT
1. Director loan accounts (DLAs) are subject to IHT. This is money owed to the director by the company. It is important to keep a DLA low or to replace it with bank finance.
Partnership capital accounts, on the other hand, are relieved by BPR and do not suffer IHT.
2. The value of private company shares is IHT taxable; however, BPR applies to shares in most trading companies at 100%.
3. Shares passing by way of a ‘double’ or ‘cross-option’ agreement are free of IHT where BPR is available, but shares passing via a ‘buy and sell’ agreement (i.e. a contract for pre-sale) is not. Check your agreements for IHT-effectiveness.
4. It is more tax-efficient to pass shares by will or agreement than to sell them and be left with cash that is liable to IHT.
Practical tip
Considerable IHT can be saved now and in the future through having a full IHT audit and review.
