Billions of pounds are paid in Inheritance Tax to HMRC every year. For some families, this can mean thousands lost from their estates. But it doesn’t always have to be that way. In fact, there are various Inheritance Tax avoidance strategies that are perfectly legal. Working under the guidance of a specialist IHT adviser will give you the opportunity to take advantage of some of these strategies, reducing your IHT liability and leaving more for your loved ones.
What is Inheritance Tax?
Inheritance Tax (IHT) is a tax on the estate of someone who has died. The estate is made up of property, possessions and money, less any debts. Everything from bank and savings accounts to investments, shares, ISAs, jewellery, antiques, vehicles and any life insurance not held in trust, as well as any gifts made in the seven years leading up to the date pf passing, are included in the estate for IHT purposes.
Certain assets fall outside of the estate, such as most types of pension plans, life insurance held in trust, and trusts generally. These assets will not be subject to IHT. Funeral deductions are generally also allowable for IHT purposes.
IHT is currently applied to estates worth more than £325,000. When the value of your estate exceeds thus limit, known as the ‘nil-rate band’, everything over the threshold is taxed at 40%, unless you are leaving it to your surviving spouse, in which case no IHT will usually need to be paid. The current nil rate band will remain in place until 2026.
The tax liability must be paid within six months of the date of death. Failure to pay within this time limit could result in a penalty being applied to the estate.
What are the best Inheritance Tax mitigation strategies?
There are various legal Inheritance Tax strategies which are acceptable to HMRC.
Make a will
Making a will is one of the easiest ways to ensure your money goes to those you want it to. A will It allows you to choose how your assets will be managed when you die, making it possible to plan for and reduce your inheritance tax bill.
If you do not make a will, the government apply the rules of intestacy to decide how your assets are distributed. This is unlikely to be the most tax-efficient method. If you are not married, or you have specific beneficiaries in mind for your estate, or you wish to leave a gift to a charity, then a will is the only way.
You can use a will to make gifts that use up your IHT allowance, and you can also use a will to set up trusts and ensure all the available IHT exemptions are used at the right time.
Setting up a will trust creates a legal arrangement where you sign over cash, property or investments to a trustee to safeguard for a beneficiary. On your death, any assets held within a trust are likely to be exempt from IHT. There are also situations where passing assets directly to the children can reduce the amount of Inheritance Tax paid.
Deed of variation
It is possible to change your will after someone dies. This is known as a deed of variation. It’s one of the most effective Inheritance Tax planning strategies, especially in situations where the beneficiary already has an IHT liability.
For example, if you have inherited a parent’s estate and you don’t need the money, you could use a deed of variation to divert the inheritance to your own children, putting it in trust until they are old enough to receive it. In such a situation, your children would not pay any IHT on the inheritance.
All the beneficiaries must agree to the changes, and the deed of variation must be effected within two years of the death. It’s a complex arrangement, so it is vital to take independent advice from an Inheritance Tax planning specialist to ensure it is carried out correctly.
Giving money or assets during your lifetime is one of the most common Inheritance Tax avoidance strategies. However, there are various rules to follow, as the value of your estate will include any lifetime gifts made within the seven years leading up to your death.
Lifetime gifts are generally either:
Exempt transfers – gifts you can legitimately make any time without incurring IHT, e.g. gifts of any value between spouses or registered civil partners; annual gifts of up to £3,000 in each tax year; regular payments out of your income that leave enough to fund your normal lifestyle; wedding or civil partnership ceremony gifts up to a certain amount, and small gifts of up to £250 per person per year. Also included in this category are gifts to charities, political parties or national organisations.
Potentially exempt transfers (PETs) – gifts to individuals and certain specific types of trusts which exceed the available exemptions above. There is no tax to pay straight away when you make the transfer, but IHT must be paid if you die within seven years and the value of the PET takes you above the nil rate band. Gifts made less than three years prior to your death incur the full 40% tax charge. Gifts made three to seven years before death are taxed on a sliding scale known as taper relief.
Chargeable lifetime transfers (CLTs) – non-outright gifts, e.g. a gift into a flexible or discretionary trust. There is no IHT to pay on a CLT, providing the total amount of CLTs in the previous seven years is lower than the available nil rate band. Chargeable lifetime transfers will usually fall outside of your estate for IHT purposes if you survive for at least seven years after the CLT was made. However, if you die within seven years of making the CLT, then its value will be part of your estate.
Putting a life insurance policy in trust is a simple way to make sure it does not count as part of your estate.
A trust works by passing ownership of the life insurance policy to named people (‘trustees’). As it is no longer yours, it cannot be treated as part of your estate when you die. This means that your beneficiaries will receive the full benefit of the policy, without any tax deductions.
Even with your life insurance in trust, your estate may still exceed the IHT threshold. However, there are ways to use life insurance for Inheritance Tax planning, effectively using the policy to pay the tax bill.
If you have a ‘whole of life’ policy, also known as ‘life assurance’, you will receive a guaranteed payout when you die, at any time for as long as the policy is in place. This is as opposed to ‘term life insurance’, which only pays out if you die within a specific period, for example 10, 15 or 20 years. Life assurance can be used to pay the IHT bill, although it will depend on its value as to how much of the bill it will be able to cover.
Looking for legal Inheritance Tax avoidance strategies? Talk to Partridge Muir & Warren.
At Partridge Muir & Warren, we have been providing professional financial, estate and tax planning services Surrey wide since 1969. As chartered financial planners, we are considered to have reached the ‘gold standard’ for our industry, which means even greater peace of mind for our clients.
We offer a comprehensive Inheritance Tax planning service, courtesy of a team of highly skilled chartered financial advisers, investment administrators, tax advisers and legal specialists. This means that you are able to benefit from all-round advice that covers every aspect of your financial and tax related needs.
If you would like to discover how our Inheritance Tax avoidance strategies could potentially save you and your loved ones money, you are welcome to get in touch.