Inheritance Tax (IHT) planning is often an area clients require advice on, but this does not come as a surprise as IHT rules can at times be quite complicated. In this article we take a closer look at some of these IHT rules and how they might affect your financial plan.

There is a common misconception that IHT only applies to extremely wealthy families, but this is not the case. With rising property prices, many families could be facing an IHT bill. In fact, the amount of IHT collected over the past five years has doubled, and over the same period the number of estates paying IHT bills has tripled.

If your estate does have an IHT liability, your executors will have to pay this bill on your death reducing the amount left to your beneficiaries. There are many ways within your lifetime that you can plan to take care of any potential IHT problems but finding the right option for you will depend on your personal circumstances.

When you die your ‘estate’ consists of the assets you leave behind, but large gifts made in the previous seven years may also need to be considered. IHT is paid on the value of the assets that a person leaves behind when they die.

If you are married or have a civil partner, you can leave your entire estate to your spouse or civil partner free of IHT. If, however you wish to leave your estate to family or friends then it may be liable for tax. If your estate is worth more than £325,000 (known as the nil rate band), and the residence nil rate band worth up to £175,000 which can be available to some estates, then HMRC will expect you to pay IHT at a rate of 40% on the total value of your estate over the available nil rate bands.

Your marital status however can mean that the rules are different. If you are single, then the rules above apply. If you are married, or in a civil partnership, then as mentioned already your assets can be transferred to a surviving spouse without any IHT to pay. Leaving assets to a spouse does not use up your nil rate band, effectively making the nil rate band of the surviving spouse £650,000. The residence nil rate band can also be transferred. Note: if you have a partner but you are unmarried, you are treated as single for IHT purposes.

Residence nil rate band

This relatively new nil rate band was introduced in 2015. Currently is it set at £175,000. There are some rules and conditions surrounding this. The main one is that the property must be left to direct descendants i.e. children or grandchildren. However, the residence nil rate band is limited to the value of the property in question, so if your property is worth £150,000 then this is the maximum that can be used against it. It is also withdrawn for estates with a value of more than £2 million.

Leaving pensions as part of your estate

In 2014, changes were made to how IHT applies to some pensions. Whether or not your estate benefits will depend on the type of pension you have and the age at which you die.

If you have a defined benefits pension (final salary) this means you will have a fixed percentage of your final salary at retirement, payable over your lifetime. The pension continues to be paid to your spouse if they survive you. It cannot be left to anyone else in its current form after you die.

If you have a defined contribution pension and it has not been taken as an annuity it’s likely to be left to your beneficiaries if you haven’t drawn it completely when you pass away. This undrawn pot can now be left free of IHT to your beneficiaries. However, income tax may be payable by beneficiaries taking pension benefits at their prevailing rate of tax if you die after age 75. If you die before 75, in most cases no Income Tax is payable.

The current rules relating to pensions are complicated, so please speak to your financial adviser before making any decisions.

Making gifts to reduce your estate’s value

You can gift £3,000 annually per annum, wedding gifts of up to £5,000 to your child, £2,500 to grandchildren, and £1,000 to anyone else. IHT is generally not paid on gifts to charities, The National Trust and political parties.

For larger gifts you will need to survive for seven years for the value of the gift to fall out of account on your estate.

Setting up a trust

Trusts are a useful tool in IHT planning, they can allow you to gift assets while retaining some rights to income or capital if needed. Trusts are often used to make sure that assets are protected for future generations. This requires complex financial advice, so you must speak with your financial adviser before making any decisions.

Investment in Business Relief qualifying assets

Business Relief (BR) can be a valuable relief from IHT and can be exempt after being held for just two years, provided the assets are still held at the time of death. Our advisers can provide advice on utilising BR qualifying investments such as: a share portfolio of equities traded on the Alternative Investment Market (AIM) of the London Stock Exchange and through Enterprise Investment Schemes (EIS).

An IHT-free ISA?

Whilst ISA’s offer valuable tax benefits, they can carry a sting in the tail for your loved ones, as they are not sheltered from IHT. Since 2013 it has been possible to invest in companies listed on the AIM market within an ISA. Provided that the companies qualify for BR then the ISA can be passed to beneficiaries in accordance with the BR rules above.

Are you looking for some help?

If you would like to find out more about any of the areas outlined above or are interested in receiving some advice, please contact Lewis Jones or George Rawlings who are happy to help.

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Important Information

This communication is issued by Capital Professional Limited, trading as Ascot Lloyd.  Ground Floor Reading Bridge House, George Street, Reading, England, RG1 8LS.  Capital Professional Limited is registered in England and Wales (number 07584487) and is authorised and regulated by the Financial Conduct Authority (FRN: 578614).

The information is based on the Company’s understanding of current UK tax legislation and HM Revenue and Customs (“HMRC”).  Levels and bases of taxation and reliefs are subject to change and their value to you will depend on your personal circumstances.