How can I reduce my inheritance tax bill?
Careful planning can help you minimise the burden of IHT, allowing your loved ones to benefit from a greater share of the wealth you accumulate during your lifetime.
High net worth individuals risk lumbering their families with very significant tax bills because HMRC charges inheritance tax at 40% on the majority of the assets they pass on. However, a range of approaches can be used to manage this liability: the ways to bring down the bill range from the relatively straightforward (use of the various IHT allowances) to the more complex (set up a company as a vehicle for your wealth and make your heirs the shareholders).
Giving away assets underlies the most common strategies. Gifts of money or assets allow your children, grandchildren or others to benefit from your wealth while you are alive – and may also reduce the share of it that is ultimately subject to IHT. However, there are rules in place to prevent you from giving away all of your assets and avoiding IHT altogether.
Where should those with several million pounds or more begin? Here's your estate planning checklist…
Take advantage of the IHT allowances
These are also available to those of more modest wealth:
- You can give away up to £3,000 each year (you can carry forward any unused allowance from the previous year).
- You can give £5,000 to a child on their marriage (or £2,500 to a grandchild).
- Gifts to a former spouse, former civil partner or a dependent relative for their maintenance and payments towards a child's education or training are exempt from IHT.
- Gifts to qualifying charities, political parties or gifts for the national benefit, such as to museums, universities, libraries or the National Trust, are also free from IHT. If you leave 10% or more of your net estate to charity, you may qualify for a reduced rate of IHT (36%).
- You can also give away "excess" income. Once you have worked out how much of your income can be considered “excess,” this is a simple but effective way to stop your inheritance tax liability from getting larger. To qualify, gifts must fall within your after-tax income and not jeopardise your lifestyle. There must also be the intent for the gift to form part of your regular expenditure. However, you are able to boost the excess income available to you by, for example, switching your investments from those that target growth to others that pay a higher income.
How can those with high net worth pay less inheritance tax?
When gifting larger amounts, you will need to take into account the “seven-year rule.” The basic principle is that if you give away assets and survive for seven years, those assets are removed from your estate and there is no IHT to pay on them.
If you die within seven years, assets that you give away may be considered as part of your estate – and subject to IHT. This will depend on the size of the gift. If it is worth less than the IHT-free allowance (known as the "nil rate band" and currently set at £325,000) it will use up the allowance, but not be subject to IHT. If it is larger, the excess could be subject to IHT. There are some important considerations to bear in mind, set out here.
So how much can you give away – and when?
You can make repeated gifts of up to £325,000 without triggering an IHT liability if you make them at least seven years apart.
You can, of course, give away larger amounts – or make more frequent gifts. However, if you die, assets in excess of £325,000 gifted over the prior seven years will still be included in your estate (though potentially benefiting from a lower rate of IHT).
You can also make gifts to trusts. Trusts can allow you to exert a degree of control over the assets you give away and may be useful in a wide range of scenarios – such as providing for very young grandchildren. Gifts into a trust are subject to slightly different rules. An IHT “downpayment” of 20% is required on the value of gifts above the nil-rate band – and if you die within seven years, additional IHT may be payable.
People often ask whether they can give their house to their children as a way to avoid paying IHT on it. In theory, the answer is yes. However, it is not always a straightforward option, as we explore here.
For those with larger amounts, a family investment company can be a useful planning tool. Assets are transferred into a company and shares then granted to family members – or others – in accordance with how much control you want them to have. Any growth in the assets is outside your estate immediately, although the seven-year rule applies to the assets gifted into the company.
How can I benefit from business relief?
There is another set of IHT exemptions which were introduced as a way to promote entrepreneurial activity.
If you established or own a business and pass it on to your children, an exemption known as “business relief” means that it will sit outside your estate. Selling the business could result in cash coming back into your estate – unless it is replaced with other business relief-qualifying investments within three years. However, in reality, not everyone can tie up a significant amount of their wealth in business ventures – and raising cash may be a requirement at some point.
There are ways to plan for this. One approach is to transfer shares in a business into a trust. In the case of business relief assets, there is no limit on how much can be transferred and there is no immediate 20% tax charge. The shares can then be sold and, if the business owner survives seven years, the proceeds remain outside the estate.
Investing in certain shares quoted on London's junior stock market, the Alternative Investment Market, is another way that investors can benefit from business relief. If held for two years before death, there is no IHT due on these investments. This can allow you to build a reasonably diversified portfolio without concentrating your assets in a handful of smaller businesses. However, the portfolio may be very volatile – and you need to be careful that your investments maintain their IHT-exempt status after purchase, as businesses can evolve and may no longer meet the relevant criteria.
The importance of advice
IHT is a hugely complex area and it is a good idea to get specialist advice from a financial adviser. IHT planning can take time to become effective and you may want to consider insurance to complement your approach. Policies can be tailored to meet your IHT tax bill, either on death or until the expiry of seven years after a gift. If the policy is "written in trust" the proceeds will be outside your estate.
Whatever estate planning methods you use, be sure to keep thorough records and pass them on to your executors. If you have significant wealth, you are likely to need advice from a lawyer and potentially tax advisers as well as financial advisers. Your will should also be drawn up to complement your IHT planning and kept up to date.
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