Tony Granger outlines some strategies to reduce inheritance tax bills now and in the future – quite legally.
Inheritance tax (IHT) is seen by many as iniquitous, as it is a death tax payable on assets that have mostly been purchased from after-tax income. No matter what your income tax status is or was, IHT is normally 40% on taxable death estates. IHT is a tax on assets after exemptions and allowances. You may have been a basic rate taxpayer all your life, only to become a 40% one on death.
In 2017, the government recovered £5.2 billion in IHT. It makes up 1% of government income, and 4% of deceased estates pay it. Taxes on deceased estates are not new – it all started with Probate Duty in 1694, over 300 years ago.
Strategies to reduce IHT
There are many ways to avoid paying IHT needlessly – but most require planning, and you may need financial advice.
Every individual has a basic IHT allowance of £325,000 (the ‘nil rate band’). If you leave your house to direct descendants, the residential nil rate band (in 2018/19) potentially adds another £125,000 per person. Some possible IHT planning ideas are outlined below.
- Plan how to leave your house – if possible, leave it to direct linear descendants to utilise the residence nil rate band, if applicable. This strategy can work even if downsizing.
- Invest in enterprise investment scheme (EIS) and seed EIS qualifying shares – holding such shares for two years generally makes them 100% IHT free through business property relief (BPR). There may also be income tax and capital gains tax advantages. You can invest up to £1 million in qualifying EIS shares and £100,000 into SEIS shares. After two years, 40% IHT can generally be saved.
- Utilise BPR reliefs – holding unquoted shares can qualify for BPR at up to 100% for IHT purposes, if certain conditions are satisfied. Consider bequeathing the shares or use a ‘double option’ agreement to transfer shares on death. If shares are sold before death, the cash proceeds may incur IHT.
- Director’s Loan Accounts – your money in the company is subject to IHT. Consider replacing director’s loan account credit balances with additional shares, which may be eligible for BPR if the relevant conditions are satisfied.
- ISA investments – many think that individual savings accounts (ISAs) are exempt from IHT. They are not. However, the tax-free status of the ISA can generally be transferred on death to a surviving spouse or civil partner. Investing into a qualifying alternative investment market stocks ISA can also save IHT after a two year holding period.
- Discounted gift trusts – making a discounted gift trust investment provides income for life and can remove a portion of the investment out of your estate immediately (the discounted portion), with the remainder potentially falling out after seven years. The investment can be gifted to your heirs on death.
- Life Policies in trust – life policies paying into trust are generally not subject to IHT. This can also be done for existing life policies, but watch out for possible IHT on the transfer.’
- Pensions – ensure that beneficiaries are appointed; otherwise, your pension fund could be subject to IHT.
- Marriage – assets left to a spouse or civil partner are generally IHT exempt. You can also inherit an unused portion of the nil rate band, so a couple can leave £900,000 tax-free (including any residence nil rate band).
- Your will – planning around the will, nil rate bands, and trusts can save IHT.
- Making lifetime gifts – lifetime gifts made to people are potential exempt transfers, which are generally 100% out of the estate after surviving seven years. £3,000 can be given away each year free of IHT, as well as small gifts (£250) to anyone, and gifts in consideration of marriage; and income gifted above your annual expenditure requirements can escape IHT.
- Gifts to charities – Legacies to charities are generally 100% out of your estate. Furthermore, gifting 10% of your estate to charity can reduce the IHT rate from 40% to 36% on your taxable estate.
Practical Tip:
There are many more strategies available, depending on individual requirements and circumstances. The above strategies are only a very brief outline. Specialist tax and financial advice based on your particular circumstances are always recommended.
