Inheritance Tax is a topic that is likely to be avoided or ignored by many, perhaps for fear of upsetting loved ones. But, if it is not addressed in good time and adequately planned, it can be an expensive oversight.
Stockport based Prest Financial Planning have looked at the question of Inheritance Tax and provided some useful hints and tips:
If the estate of a deceased individual is valued at more than the “nil rate band” of £325,000 (or £650,000 for a married couple/civil partnership) then any assets above this value are likely to suffer Inheritance Tax (IHT). This is, in the 2018-19 tax year, charged at 40 per cent.
IHT can potentially be mitigated in a number of ways, including through the application of the Residence Nil Rate Band, a special allowance that relates to the family home. It is also possible to invest a proportion of your capital in assets that can benefit from relief from IHT. By and large these tend to be riskier investments.
There is, though, a simpler answer. IHT was famously described by the former Chancellor of the Exchequer Roy Jenkins as “a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”. If you do trust your children then the most effective way to reduce the IHT bill your estate will eventually face is to reduce the size of that estate by giving a proportion of it away during your lifetime.
The seven-year rule
Planning ahead is important. While smaller gifts can fall immediately outside your estate, most larger gifts to individuals will take the form of “potentially exempt transfers” (PETs), which take seven years to fall entirely outside your estate and be completely free of IHT.
PETs begin to fall outside your estate from three years after the gift is made, with IHT charged on a tapering scale if you die between three and seven years after making the gift. It is not, therefore, necessary to survive for the full seven years to gain some benefit.
For IHT purposes gifts include not just transfers of things such as money, property, possessions and stocks and shares but also any losses incurred when something is transferred for less than its fair market value. For example, if you sold a house worth £200,000 to your child for £150,000 then this would count as a £50,000 gift.
A question of trust
How much you trust your heirs and whether you will still need access to the assets during your lifetime are, of course, big considerations. These issues can often be addressed by making gifts into trust.
Trusts provide greater control during your lifetime and, potentially, beyond. However, this control comes at a price and many large gifts into trust will be treated by HMRC as “chargeable lifetime transfers” (CLTs). This means an IHT charge could be levied at the time the gift is made and further charges could be payable, periodically, during the lifetime of the trust – IHT is not only a tax on the deceased!
Gifts into trust, and the tax treatment they receive, are very complex and we always recommend seeking expert, qualified financial as well as legal advice before proceeding.
In summary, lifetime gifts can broadly be divided into the following categories:
- Smaller gifts of up to £250 per beneficiary or £3,000 per individual donor, which fall immediately outside your estate. Wedding gifts can also benefit from their own exemptions, up to a certain level.
- Gifts made out of income (not capital), which fall immediately outside your estate.
- Larger gifts to individuals, which take seven years to fall entirely outside your estate.
- Gifts into trust, which often incur immediate and ongoing IHT charges.
Help when it matters most
Making lifetime gifts is often an effective way of reducing an estate’s IHT bill and can also be rewarding because gifts are generally made at a time when they can make a real difference to the beneficiaries’ quality of life.
It is important, though, also to consider whether you can afford to make such gifts. For this reason we recommend that any sustained or substantial gifting activity should only be carried out as part of a professionally constructed financial plan that includes a lifelong cash flow forecast.
Important: Estate planning and tax advice are not regulated by the Financial Conduct Authority (FCA), although investment advice that may form part of the implementation of any such plans is regulated by the FCA.