By Samantha Clarke, Chartered Paraplanner with Anstee & Co.
Inheritance Tax (IHT) is paid on the value of the assets that a person leaves behind when they die. It can also apply to some gifts that are made before someone dies.
If you are married or have a civil partner, you can leave the entire estate to your spouse or partner free of inheritance tax. But if you want to leave some or all of your estate to family and friends, then it may be liable to inheritance tax.
What is the Inheritance Tax rate
The rate of Inheritance Tax is currently 40%. There are several ways in which it can be reduced, but all of these need planning.
You pay Inheritance Tax on your ‘estate’. The value of your estate (assets) is the total of the following:
- the value of any property shareholdings you have
- how much cash you have in the bank
- the value of any business shareholdings you have
- the value of your vehicles
- your Premium Bonds
- ISAs, shares, or investments (including those held in trust for less than 7 years)
- any residential rental payments you’ve made in advance
- any due life insurance or term insurance pay-outs that are not in a trust
- anything you own of worth
Less the liabilities to your estate of the following:
- the outstanding mortgage left on your home
- what you owe to finance companies, for example, loans, credit cards, and bank overdrafts
- any unpaid or accruing household bills.
- an overdrawn directors’ loan account (if the company does not write it off upon your death)
- any director’s guarantee you have signed (so that your company could access finance – there is a strong chance the guarantee could be called upon by the lender upon your death).
The resulting figure is the amount that will be assessed for IHT.
- If cash is held within a company with no identifiable business purpose, then that part could fall within a deceased estate for IHT purposes. Cash in a company (cash which isn’t being used) could be treated as an excepted asset by HMRC on death and as such will not benefit from Business Relief. This means if the business owner died then Inheritance Tax (IHT) would be payable on this cash/excepted asset even if the rest of the company did qualify.
- Certain assets are not included for assessment against IHT and these are covered later on in this document.
Nil Rate Band (NRB)
Everyone has a tax free inheritance tax allowance which is called the Nil Rate Band (NRB). This is currently £325,000 for the 2019/20 tax year, which can be offset against their overall estate wealth.
Unused Nil Rate Band
If someone leaves gifts to their surviving spouse or civil partner, they are exempt from Inheritance Tax. If they have not used any or all of their own nil rate band, the amount unused is available to increase that of their spouse or civil partner when they die – even if they remarry. The percentage unused at the time is the amount available for use by the surviving spouse or civil partner.
Residential Nil Rate Band (RNRB)
From 6 April 2017, an additional Inheritance Tax (IHT) allowance has been available when a person leaves a residential property to direct descendants. Should there be more than one residential property in an estate, only one will qualify for the allowance.
Direct descendants include children (including adopted children, step-children and foster children) and their linear descendants. It does not include brothers, sisters, nieces and nephews of the deceased.
The allowance is being phased in and is currently an additional amount of £150,000 per individual. It will increase in the next tax year 2020/21 to £175,000 and will then increase with indexation from each tax year thereafter.
Where an estate is valued at over £2 million, the RNRB will be reduced at a rate of £1 for every £2 over the £2 million threshold. This means that there will be no RNRB on a first death if the estate exceeds £2.30 million in the current tax year.
No RNRB will be available for people without children e.g. two sisters living together.
The new RNRB is transferable to a surviving spouse or civil partner in the same way as the Nil Rate Band.
Exemptions from IHT
There are various exemptions from IHT and transactions that are not taken into account; some of which are summarised below.
- Gifts to spouse or civil partners.
- Regular gifts from your surplus income (no limit if the expenditure does not affect individual’s standard of living. Records of these gifts, however, must be kept. Note: income from an investment bond cannot be included).
- Annual £3,000 exemption – can be carried forward for one year only if unused
- £250 small gifts exemption (assuming no more than one £250 is given to an individual in one year)
- Exemption for marriage gifts – £5,000 from a parent, £2,500 from a grandparent, £2,500 from a bride or groom, or £1,000 from any other person
- Gifts to UK registered charities, some national institutions such as museums, universities, the National Trust and also political parties.
Certain gifts are not “Transfers of Value” for IHT purposes, of which some are as follows:
- Maintenance of dependants
- Waivers of remuneration
- Interest-free loans
- Disclaimers of legacies
- Deeds of variation (to a Will or Intestacy)
- Business Property and Agricultural Property Relief, deductions of 50% or 100% can usually be made in respect of the value of assets employed in a trading company or farming business depending upon the specific details.
- Investments in AIM (Alternative Investment Market) usually qualify for Business Property Relief
Potentially Exempt Transfers (PETs)
Lifetime gifts of assets, not subject to an exemption, relief, etc. are deemed to be PETs and fall outside of the Donor’s estate after the expiration of 7 years from the date of the gift. If they don’t survive the gift by 7 years, the PET becomes a Chargeable Consideration and is added to the value of their estate for IHT. If the combined value is more than the IHT threshold, IHT may be due. Taper relief applies if the individual dies between 3 and 7 years of making the gift, in which case tax due on the gift made subject to IHT will be:
Year 3 to 4 32% Year 4 to 5 24%
Year 5 to 6 16% Year 6 to 7 8%
Any lifetime transfer that is “Potentially Exempt” must meet certain conditions. The transfer is a gift made by an individual to another individual or to a specified trust. This means, for example, the gift cannot be made from or to a corporation or company.
Gifts where you retain an interest in it, no matter when the gift was given, does not qualify as a PET.
Who pays the IHT bill?
Inheritance tax due on money or possessions passed on when an individual dies are usually paid from their estate.
An individual’s estate is made up of everything they own, minus debts, such as their mortgage, and expenses such as funeral expenses.
An individual’s heirs must pay IHT by the end of the sixth month after the person died. An inheritance tax reference number from HMRC is needed first and should be applied for at least three weeks before a payment needs to be made. A solicitor is usually employed to help with administering on an estate.
However, if the tax is due on gifts made during the last seven years before the individuals’ death, the people who received the gifts must pay the tax.
If they can’t or will not pay, the amount due then comes out of the deceased individual’s estate.
It is worth noting that assets assessed against IHT cannot be released to the intended beneficiaries until such time as the IHT liability on the deceased estate has been paid.
Your Inheritance Tax planning options
There are several options available to deal with an Inheritance situation as follows:
USE IHT EXEMPTIONS AVAILABLE
Please refer to IHT section earlier in this document for the IHT exemptions available to you.
Cost: The amount gifted.
- Reduces IHT liability immediately as not counted towards your final estate.
- May help out those you gift to at a time when they most need it, rather than waiting until you are no longer here.
- For those with estates that only just fall into the IHT liability, you may gift monies that you find you need later on in life – such as for Long Term Care costs.
- Tax rules can change at any time.
OUTRIGHT GIFTS (PETs)
Outright gifts are gifts of sums of money or assets outright without the expectation of receiving this back in the future.
- Outright gifts will provide funds to the recipient at the time they may need it rather than receiving it when you are no longer here.
- You have greater control over how your wealth is distributed.
- These fall outside your estate after 7 years.
- They can minimise the amount of Inheritance Tax payable on your death.
- Outright gifts would be liable to IHT if you die within 7 years of the gifts being made. The tax is payable by the recipient of the gift.
- With outright gifts, you will lose access to your capital and will have no control on how the monies are spent by the recipient.
SELL SOME OF YOUR PROPERTIES & REINVEST ELSEWHERE
Cost: Cost of selling/purchase of new investment
Capital Gains Tax (if any gains made over and above £12,000 allowance in this current tax year and no CGT deferral opted for)
With the resulting monies, it is possible to invest these into alternative assets that fall outside your estate, namely EIS’s, AIM portfolios and pension plans.
- Recycling of assets into more IHT efficient vehicles.
- Any rental income lost from the sale of properties can be taken from other assets within your Estate for IHT purposes. This will help to reduce the overall liability on death.
- You may make a loss on the sale of properties albeit that this could be offset against any potential gains realised elsewhere.
It would be useful to have further information relating to the purchase price and additional costs of purchase for your additional property if you consider this option.
ALTERNATIVE INVESTMENT MARKET (AIM) SHARES
AIM was launched in June 1995 and offers the benefit of investing new monies or recycling of assets/cash into more IHT efficient vehicles and are a potential alternative to making lifetime gifts. It allows smaller, less-viable companies to float shares with a more flexible regulatory system than applies to the main market.
Portfolios of AIM companies typically target growth and generally qualify for Business Property Relief (BPR) so fall outside your estate for IHT purposes after being held for 2 years.
On death, the portfolio can be transferred to a spouse without losing the IHT exemption or can be sold or transferred to other beneficiaries.
There is no restriction on the maximum amount you can invest into AIM shares but typically providers require a minimum of £100,000.
In 2013, the Government made it possible for investors to hold AIM-listed shares in an ISA, providing tax-free growth on any gains, in addition to the BPR benefits.
AIM shares held outside of an ISA will be subject to Capital Gains Tax on the growth made on withdrawals.
AIM shares do come with the additional investment risk of investing in companies that are not listed on the London Stock Exchange. Shares on AIM are traded so might take longer to buy or sell a specific holding than on the main market. There could be large differences between buying and selling prices and you may not get back your original investment.
ENTERPRISE INVESTMENT SCHEMES (EIS)
EIS was launched in 1994 and is designed to help smaller and typically higher-risk trading companies raise finance. This is done by offering a range of tax reliefs (30%) to investors who purchase new shares in these companies.
As with AIM shares, they also offer the benefit of investing new monies or recycling of assets/cash into more IHT efficient vehicles and qualify for Business Property Relief and will, therefore, be exempt from inheritance tax after 2 years.
There is a restriction on the maximum amount you can invest into EIS on which tax relief can be obtained of £1 mil (or £2 mil if invested in knowledge-intensive companies) and the minimum is typically £10,000.
How long must EIS shares be held?
EIS shares must be held for three years to benefit from the other tax advantages they come with.
Capital Gains Tax is not payable on any gains made from the EIS unless you have used the Capital Gains Tax deferral relief in which case any Capital Gains Tax (CGT) liability that you incur on other assets sold down can be deferred within an EIS until the shares are disposed of. If you hold the investment until death, the deferred capital gains tax is eliminated.
EIS investments are income tax reducers with up to 30% tax relief available on the investment made. If you sell your EIS shares before the three-year minimum holding period ends, you will have to repay any income tax relief you have claimed.
If EIS shares are disposed of at a loss, the loss, after-tax relief, can be offset against either income or capital gains tax.
The companies that an EIS invests in are often unlisted so you may have to wait until the company is sold or has large enough cash reserves to buy back its shares from investors. There is generally little or no secondary market for the shares in an EIS and investors are likely to be unable to sell to get any money back via this route and given their high-risk nature, you may not get back your original investment.
AIM PORTFOLIO / ENTERPRISE INVESTMENT SCHEME
Either taking funds from existing assets inside your estate or investing new monies from cash deposits
Cost: Cost of the AIM /EIS manager – normally charged as a % of the amount invested.
Any performance fees charged by the EIS provider.
- Recycling of assets/cash into more IHT efficient vehicles.
- You can utilise your ISA allowance to invest in AIM shares – providing tax-free growth on any gains.
- Shares held in AIM / EIS generally qualify for Business Property Relief (BPR). They will be outside your estate after 2 years.
- Any Capital Gains Tax (CGT) liability that you incur can be deferred within an EIS until the shares are disposed of. If you hold the investment until death, the deferred capital gains tax is eliminated.
- EIS investments are income tax reducers with up to 30% tax relief available on the investment made.
- You will pay no capital gains tax on any profits made from an EIS investment or any AIM shares held in an ISA.
- If EIS shares are disposed of at a loss, the loss, after-tax relief, can be offset against either income or capital gains tax.
- Shares on AIM / EIS might lose their qualifying status if they fail to comply with relevant criteria or if legislation changes.
- Shares on AIM are traded but it might take longer to buy or sell a specific holding than on the main market. There could be large differences between buying and selling prices.
- If you sell your EIS shares before the three-year minimum holding period ends, you will have to repay any income tax relief you have claimed.
- AIM and EIS’s are considered high-risk investments and you may not get back your original investment.
Under current legislation, most pension plans fall outside of an individual’s estate for IHT purposes.
It is possible to fund pension contributions up to a maximum of £3,600 per annum where there are no pensionable earnings (i.e., Salary, bonuses etc) or 100% of pensionable earnings up to a maximum of £40,000 per annum where pensionable earnings are present.
It may also be worthwhile funding pension plans for children for their future retirement using each of your annual IHT exemptions. The cost of this would be £2,880 per annum (£3,600 gross pa) per child assuming they have no pensionable earnings
Donor contributions made on behalf of another, will attract tax relief for the recipient of basic rate tax relief and are deemed to be contributions made by the recipient so further tax relief might be available to them depending on their own level of pensionable earnings. Their contributions will also be outside their estate for IHT purposes.
Pensions cannot be accessed until age 55 however this is set to rise to age 57 from 2028 when the state pension age increases from 66 to 67 and will remain 10 years below the state pension age from then onwards. A pension vehicle does, however, offer the ability to take 25% as a tax-free lump sum with the remainder being available as income assessed under PAYE rules. Any funds not taken can be passed on to a beneficiary of your choosing whilst still remaining outside of their estate for IHT purposes.
Cost: Cost of the product provider – normally charged as a % of the amount invested.
- Saving into a pension plan is a tax-efficient way to generate a fund to provide an income in retirement.
- If you fund child pensions, they will hold funds that are also outside of their estate for the purposes of IHT planning.
- Money held in a pension plan is not accessible before age 55 and many people find it beneficial to remove the ability to spend savings before retirement.
- Recycling of assets/cash into more IHT efficient vehicles reduces your IHT liability.
- State pensions alone are unlikely to be sufficient to provide a suitable income in your retirement years.
- Tax relief on pension contributions.
- Values of investments can fall as well as rise and you might not achieve the returns hoped for.
- Tax reliefs and rate can change at any time and depend upon your personal circumstances.
- Money held in a pension plan is not accessible before age 55 however this is set to rise to age 57 from 2028 when the state pension age increases from 66 to 67 and will remain 10 years below the state pension age from then onwards.
WHOLE OF LIFE POLICY
A Whole-of-life Policy plan is a life assurance policy which guarantees to pay out a lump sum (sum assured) when you die, whenever that is, so long as you maintain payment of premiums to it, up to the date of death. The size of the payout depends on the level of cover taken out as outset.
These types of plan are normally written on a joint life, 2nd death basis for married couples, with the benefits written in trust. This ensures that cover is provided to pay towards the IHT bill due on the second death and writing the policy in trust for beneficiaries ensures the payout is outside your estate for IHT and payment can be made promptly without the need for probate.
Contributions made to pay for the cover may be available under the ‘payments from surplus income’ for the purposes of IHT planning, but this depends on the cost of providing the lump sum required to cover the expected IHT liability.
Cost: Dependent on the amount of IHT liability to be covered, your age and your health
- No changes needed to existing assets.
- You will have the peace of mind that your family/dependants will have life cover to pay towards your IHT liability.
- Writing the policy in trust for your beneficiaries will ensure the payout is outside your estate for IHT and payment will be made promptly without the need for probate.
- If the cost of the premiums to provide the cover is not within the annual IHT allowance (£3,000 per annum per person) this may give rise to IHT, although premiums may be considered as ‘gift out of normal income’ if the payments do not impede on providing for your normal standard of living. Income means net income after tax so would exclude gifts from the capital but would include salary, commissions, dividend income from shares, rental income and interest paid on a bank or building society accounts. Gifts out of normal expenditure will not normally qualify for the exemption if you have to resort to capital to meet your living expenses.
- No one knows how long they will live. Premiums have to continue until 2nd death for the cover to be paid out.
- Your IHT liability could be more or less than the current IHT liability depending on how your assets grow or decrease in value.
- You will not get back any premiums paid. The cover is only paid out on 2nd Death
- You need to be in reasonable health to be able to obtain a Whole of Life plan.
A trust arises when assets and property are put under the control of one set of people (trustees), for the benefit of another set of people (beneficiaries).
Setting up a Trust allows the executors of your estate to distribute the assets without the need for probate after your death. A trust arises when assets and property are put, by the donor, under the control of one set of people (trustees), for the benefit of another set of people (beneficiaries).
Assets in Trust do not form part of an individual’s estate, providing the donor lives for seven years after placing the assets or monies into Trust.
Gifts made to a Trust are charged at a tax rate of 20% of the value over any unused NRB. Also, there can be ten-year periodic (normally 6% of the value over the unused NRB) and exit charges if the value of the funds placed into a trust is more than the unused NRB. (This does not apply to bare trusts).
You can set up multiple trusts but if a subsequent Trust is set up within seven years of the first, you can only offset the amount of inheritance tax allowance unused against the 20% tax charge on set up.
There are a variety of trusts that can be set up; these are dependent on a particular individual’s circumstances so are not covered in this document; further information can be provided, specific to your needs, once established.
Any gifts you have already made within the last 7 years, which are not regarded as IHT exempt, will be counted toward your current IHT Nil Rate Band when calculating any tax charge due on the Trust on death.
Cost: The amount placed into Trust – amount given outright.
For a Trust. – Cost of the provider of the underlying investment vehicle – normally expressed as a % of the sum invested.
- You have greater control over how your wealth is distributed.
- A Trust usually gives the settlor some element of control over what happens to the money, which appeals to many investors.
- Setting up a Trust allows the executors of your estate to distribute the assets without the need for probate after your death.
- Trusts can protect your interests and those of your beneficiaries.
- Trusts can protect your assets should your spouse or partner need nursing care in the future.
- Most Trusts fall outside your estate after 7 years’ although, with Loan Trusts, the loan element must be paid back.
- Can minimise the amount of Inheritance Tax payable on your death.
- Depending on the type of Trust set up, you may lose full access to your investment.
- Depending on the type of Trust set up, there can be complexity in establishing and maintaining a trust structure
- Gifts made to a Trust are charged at 20% of the value over any unused NRB. Besides, there can be ten-year periodic (normally 6% of the value over the unused NRB) and exit charges if the value of the funds placed into a trust is more than the unused NRB. (This does not apply to bare trusts).
To encourage more people to leave money to charity, any cash or physical asset you leave to a qualifying charitable body, either during your lifetime or in your will, would be exempt from Inheritance Tax (IHT). This could be to a charity, museum, university, the National Trust, it could also be to a political party.
This can also reduce the rate at which IHT is due from the current rate of 40% down to 36%. This reduced rate would only apply if the value gifted to charity amounted to at least 10% of the “net estate” at the date of death. Generally, the net estate is defined as the value left over after deducting any exemptions (including your available nil rate residence band) and any other available reliefs. This can be bequeathed via your Will.
You can choose whatever charity you want to leave funds to so long as they are a registered charity recognised by HMRC.
These gifts can be bequeathed via your Will.
Cost: Amount gifted to Charity
- Reduction in IHT liability on death.
- You can choose whatever charity you want to leave funds to so long as they are registered charity recognised by HMRC.
- Any monies left to charity will potentially mean less given to the beneficiaries of the remainder of your estate
It is important that you create a Will to ensure that your assets are left to those that you would wish to benefit. This should be reviewed regularly to ensure it remains in line with your wishes.
How Anstee & Co can help you with Inheritance Tax planning.
We are a firm of Independent Financial Advisers (IFA’s). This means that the advice we provide is unbiased. We look at all the financial planning options available to you.
Why not arrange a meeting to see how we can help you. The initial fact-finding meeting is out our expense. Meetings can be arranged at a time or location that is convenient for you. We have offices located at-
- Kettering, Northamptonshire
- Stamford, Leicestershire
- Towcester, Northampton
- London, Pall Mall, Greater London
Additionally, our financial planners live and make use of meeting rooms in-
- Bedford, Bedfordshire
- Market Harborough, Leicestershire
- Northampton, Brackley and Wellingborough in Northamptonshire
The information contained in this article is for information purposes only and does not constitute advice. No action should be taken based on this information alone.