Top 10 Tips for Inheritance Tax Planning

Lubbock Fine, 31 January 2019

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Planning to mitigate inheritance tax (IHT) is a relatively easy and painless way to ensure that your hard earned cash goes to those who you want to inherit, rather than to the Treasury. Here are our top 10 planning tips.

1. Make a will

According to 60% of individuals do not have a will. A will is not strictly a tax planning technique but having one ensures that you can dictate (to a point) who inherits your estate. The intestacy rules won’t necessarily direct your assets to the right people, but, additionally, intestacy can result in IHT being due when, with the right will in place, none would have been payable.

2. Potentially Exempt Transfers (PETs)

There is no IHT due on an outright gift at the point of gifting, although capital gains tax may apply on some gifts so care is always needed. However, if the individual lives less than seven years after the gift, then the gift is considered a ‘failed PET’, and dependant on year of death within those 7 years, a tapered tax applies. It therefore pays to consider making capital gifts to children when your life expectancy is still good to maximise the chances of saving IHT on the gift. 

3. Gifts made out of income

An underused and fairly generous exemption allows those with more income than they can spend to gift away the excess without any IHT consequences. For some this may be more suitable than a single, large, outright gift. There needs to be an intention to make a series of regular gifts which do not affect the donor’s living standards and if conditions for the exemption are satisfied, the gifts are exempt from IHT as soon as they are made; you do not have to survive for seven years after making them. The benefit of this exemption is that you can use the gifts to pay for life policy premiums, regular pension contributions for family or regular gifts into a trust as well as gifts to individuals directly.

4. Gift Annual Exemption

While still alive, you have a £3,000 annual IHT exemption. An extra benefit is unused allowance from the previous year can be carried over to the current year, so if you haven’t used the exemption before, then you would be able to make gifts of £6,000. This is only allowable for one year.

5. Pensions & Pension Contributions

Your pension pot does not count towards your estate when calculating IHT. If you die with an intact pension pot before the age of 75 then that unspent cash will pass to beneficiaries tax free. Where the pension holder dies over the age of 75, then their beneficiaries can withdraw cash in lump sums or as a regular income but must pay income tax on the withdrawn funds at their own marginal rates.

Pensions are a complex area and much will depend on the holder’s circumstances. Any funds withdrawn from the fund, such as 25% tax free cash lump sum, and unspent at the point of death would be counted towards the IHT estate.

The rules regarding income tax relief for pension contributions are complicated so please take advice before making pension contributions, particularly if you earn over £150,000.

6. IHT relief for investments in qualifying companies

Another approach to IHT planning is to change the nature of your assets to something that is eligible for relief. The government encourages investments designed to help smaller, higher risk trading companies raise finance by offering a range of tax reliefs to investors who purchase new shares in those companies. Broadly, the two main schemes are the Enterprise Investment Scheme or EIS and, for really small start-ups, the Seed Enterprise Investment Scheme (SEIS). Both schemes come with conditions but offer IHT relief if an individual holds the shares for two years or more. There are income tax and capital gains tax benefits too.

7. Trusts

Many people feel that they would like to pass down assets to their children but are concerned about the children’s ability to deal with those assets. A trust allows an individual to retain control but not ownership of assets passed to a beneficiary.

Whilst a gift into trust enables the donor to extract assets from their own estate, there is a separate IHT regime for trusts and so care is needed. Capital gains tax planning is also required for the gift of any assets standing at a gain.

8. Insuring the liability

One way to guard against leaving an individual’s family with a large tax bill is to buy a life insurance policy, a tactic increasingly used to help clients to plan for their IHT liability.

These policies can either be term period such as 5 to 10 years or a whole of life, which is active for the individual’s full life. Both types of policy are based on paying a monthly premium and calculated by insurers according to an individual’s age and health, and a lump sum is paid on the insured’s death. It is important to ensure the life insurance policy is put in trust, taking the proceeds outside the insured’s estate for IHT purposes.

9. Loans to your trading company

If you’re the owner of a trading (as opposed to investment) company, you may well have lent money to it to fund working capital or additional investment in the business. The shares that you own should be exempt from IHT if you’ve owned them for two years or more. However, any funds that you have lent to the company are also an asset of your estate and are not IHT free. It may therefore make sense to convert debt funding to shares in order to maximise the exemption from IHT.

10. What else can be given away free of IHT?

Every individual can gift up to £250 to as many individuals as they wish in any one tax year and this is alongside their £3k gift annual exemption. Please note, the £250 gift cannot be given to an individual who has received any part of the £3k annual exemption.

In addition, an individual can give wedding/civil ceremony gifts (within limits), gifts to political parties and charities as well as gifts to assist minors and elderly relatives with living costs.

These gifts are exempt therefore not classed as a chargeable transfer or taxed or included in cumulations for IHT purposes.

For further information on IHT planning, please speak to your contact partner or to senior tax partner Clare Munro, or to Andrew Tricker chartered financial planner or 020 7490 7766

Please note that this article is based on information deemed relevant at the close of the 2017/18 tax year and going into 2018/19 tax year. Allowances and regulations are subject to change and it is advisable to seek up-to-date advice before acting on these recommendations.