Inheritance Tax Planning – An example.

By Barnes Gladman, Financial Planner.

Inheritance Tax (IHT) is paid on the value of a person’s estate when they die. However, after a lifetime of paying taxes and making provisions for the future, a 40% charge on assets upon death can be difficult to accept. With years of house price rises, this is a challenge many people now face. So, Inheritance Tax Planning is key.

Every individual is currently entitled to a £325,000 Nil Rate Band, before paying any IHT. This is extended by a £175,000 Residential Nil Rate Band if a property is owned and passed on to direct descendants, provided that the total estate does not exceed £ 2 million. This means a married couple can have an estate worth up to £ 1 million, before paying any Inheritance Tax.

For people whose estates exceed the IHT allowances, planning is not solely around passing on assets to the next generation, but also ensuring they can enjoy the now.

When it comes to passing on assets or protecting them from IHT, there are a few options, that this case study will highlight.

John and Sarah, their story.

John and Sarah are both 63 years of age and wish to retire on John’s 65^th birthday in December 2024. They have built up a portfolio of investments alongside contributing to defined contribution pensions. In addition, John was a member of his first employer’s defined benefit pension scheme, which he intends to accept with the maximum income permitted.

John and Sarah have confirmed they are both medium to high-risk investors through the completion of risk assessment questionnaires.

John earns £63,000 gross per annum in his role as Purchasing Director, which makes him a higher-rate taxpayer. John is also in receipt of £2,825 dividend income from his OEIC and share portfolio. John’s ISA produces an annual income of £1,750.

Sarah earns an annual salary of £48,000 as a Supervising Architect and is therefore a basic rate taxpayer. Sarah’s ISA produces a further £1,500 income annually.

John and Sarah’s Assure Bank joint savings account produces £100 income annually.

John and Sarah wish to consider their options about mitigating inheritance tax, without making substantial gifts and losing access to their capital and assets.

Other assets/policies:

• Final salary defined benefit pension scheme – £2,300 gross pa – John.
• £252,000 sum assured death-in-service – John.
• £192,000 sum assured death-in-service – Sarah.

John & Sarah have amassed a substantial wealth of approximately £1,829,000 of which £794,000 is held in liquid assets.

Current Inheritance Tax potion.

As of the 22/23 Tax Year, John & Sarah have a combined IHT allowance of £1,000,000 with NRB & RNRB. Their current assets total approximately £1,829,000. Pensions are not considered part of the estate for IHT purposes, which means the estate is valued at £1,394,000. The (22/23) allowance is therefore exceeded by £394,000 and liable to inheritance tax.

£394,000 @ 40% = £157,600 IHT liability payable.

Considerations.

• John and Sarah’s combined Nil Rate Band totals £650,000 (£325,000 x 2).
• As John and Sarah’s overall estate totals less than £ 2 million, and they own a residential property which is to be left to direct descendants, they qualify for the Residence Nil Rate Band.
• In 22/23 the RNRB is £175,000 per person, meaning John and Sarah have an additional £350,000 on top of their combined £650,000 NRB. This means John and Sarah’s IHT allowance totals £ 1 million.
• Both John and Sarah are well within their current pension Lifetime Allowances of £1,073,100 in 22/23 (John – £230,000 / Sarah – £205,000).
• Both John and Sarah are well within their £40,000 pension Annual Allowances for 22/23.
• Neither John nor Sarah have utilised their £3,000 annual gift allowances.
• John and Sarah stated within their factfind, no intention of making any substantial gifts.
• Both John and Sarah have employer Death in Service schemes which will pay out upon death and increase the estate of the survivor (John – £252,000 / Sarah – £192,000). However, these policies will end when they retire next year and cease to be relevant.
• John and Sarah have up-to-date Wills, leaving all assets to the survivor and then to the two children in equal shares on the second death.

Suitable Options for Inheritance Tax Planning.

1. Pension Contribution – Pensions are considered outside an individual’s estate for IHT purposes. At current values it appears unlikely either John or Sarah will breach the pension LTA, leaving scope for potential investment. Pensions are very tax-efficient wrappers, as touched upon earlier in this report there are many income and capital gains tax benefits to pensions, whilst ‘it is tax efficient to keep savings in a pension fund and pass it down to future generations’. They could utilise CGT allowances to move assets into pension wrappers, access bond withdrawals or employ cash reserves to fund pension contributions.
2. Business Property Relief Qualifying Investment – ‘Investments that qualify for BPR can be passed on free from inheritance tax upon the death of the investor, provided the shares have been owned for at least two years’. An example is AIM shares: Shares listed on the Alternative Investment Market, for smaller, growing companies in the UK and abroad. Once held for two years, become free from IHT. A higher-risk investment, which offers some liquidity due to being listed on an exchange. AIM shares can be held within ISA wrappers to enhance tax efficiency. These types of investment offer John and Sarah the ability to retain an asset and benefit from income and growth, whilst reducing their IHT liability.
3. Trusts – John and Sarah can utilise trusts in their IHT planning. As they  stated they had no plans to make substantial gifts, a Loan Trust may be suitable: Using a Loan Trust allows them access to their original capital at any point and in any amount, however, any growth will not be included in the estate for IHT purposes. John and Sarah can take income withdrawals and loan repayments until the loan is exhausted.
4. Gift Allowance – Whilst John and Sarah do not wish to make substantial gifts, they both have a £3,000 annual gift allowance available should they wish to reduce their taxable estate.
5. Whole of Life – A WOL policy could be set up in trust, to pay the IHT liability upon the second death. However, the annual premium would have to be accounted for in John and Sarah’s retirement income planning.
6. Spend – A simple way of reducing John and Sarah’s IHT liability is spending money and enjoying retirement.

In Summary

There are many options available to John and Sarah with regard to reducing their potential Inheritance Tax bill, and ensuring future generations are looked after financially.

How Anstee & Co can help you with Inheritance Tax Planning.

Do you need some help with Estate Planning?

Do you want to consider Environmental and Social factors within your financial plan? Please see the previous article Inheritance Tax Planning – Can it be green?

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