Tax Planning

Inheritance tax planning

The amount left tax free on death, including any lifetime gifts made in the previous 7 years, remains at £325,000.

Where a home, which the deceased lived in, is given to a child or grandchild, a further residence nil rate band (RNRB) of £175,000 can be claimed, giving £500,000 tax free. Assets above these allowances are taxed at 40%.

Estates, over £2 million, do not fully benefit from the RNRB. For every £2 over £2million, the allowance reduced by £1. Estates over £2,350,000 get no RNRB. Those who have no children or grandchildren miss this additional relief.

Gifts made between spouses and civil partners are exempt from IHT. Furthermore, if the spouse or civil partner who dies first has any of their allowances unused, they are available to the survivor of the couple, so that no IHT is due on up to £1,000,000 on the second estate.

Couples who are not married or civil partners do not enjoy these exemptions. This can result in the survivor of the couple facing an inheritance tax liability if they inherit more than £325,000 from their deceased partner.

Estates left to charity, or political parties, are exempt from inheritance tax. Where 10% or more of an estate is bequeathed to a charity, the balance of the taxable estate is taxed at 36% instead of 40%.

Estate planning strategies for inheritance tax

One off giving

Reducing one’s estate to below the tax-exempt allowances will reduce IHT payable. One off capital gifts of up to £3,000 per year, per donor, are exempt and can be carried forward for one tax year. Parents may give £5,000 on marriage, grandparents £2,500 and others £1,000 tax free. Small gifts of up to £250 per year per recipient are exempt.

Other one-off lifetime gifts fall outside the estate after 7 years. Outright gifts are potentially exempt transfers – no tax is payable unless the donor dies within 7 years of making the gift, when its value is added back to the estate, discounted by 20% per year from 3 years onwards.

Before making substantial gifts, it is important to consider affordability and the impact on your standard of living over the longer term. Saving inheritance tax should be a secondary goal to maintaining an adequate income. Bear in mind that income from pensions will fall following death of the first of the couple to die. Should care costs arise in later life, taxpayer support may be withheld if the individual is deemed to have deprived themselves of assets to avoid meeting their own care bills.

Timing of larger gifts can be tricky. The sooner made, the more likely the donor will survive 7 years, when the gift falls out of their estate. But what if the timing is not right from the recipients’ point of view? Giving large sums to children ill equipped to manage it can result in a greater loss of family wealth than the 40% IHT charge.

This concern can be overcome by placing a gift in a discretionary trust with conditions attaching to when the beneficiaries may access the funds, or on how they might be used. The donor can be a trustee and continue to exercise control over this.

Gifts to discretionary trusts are chargeable lifetime transfers and carry an immediate tax charge of 20% of the value of the gift, once it, and other gifts made in the previous 7 years, exceed the nil rate band of £325,000. If death occurs within 7 years, the gift is added back to the estate. The trust will pay an IHT charge of 6% of trust assets every 10 years.

Where gifts are made both outright and to a discretionary trust, exceeding the £325,000 nil rate band, it is important that the gifts to the trust are made first or an immediate tax charge will arise.

Regular Giving

Regular giving of any amount is tax exempt if it arises from surplus income, as opposed to capital, and does not reduce the donor’s standard of living. To qualify for this exemption the payments must take place over more than one tax year and the donor must demonstrate they arise from surplus income.

exempt assets

Assets exempt from IHT include defined contribution pension pots, lump sums payable on death from pension schemes, assets in trust and some business assets.

Defined contribution pension pots, and lump sums payable from them on death, do not usually form part of a taxable estate. They may be left to anyone and can be passed on over several generations. The owner pension should complete a nomination form and lodge this with the scheme trustees, so the trustees know who they wish to benefit. Update these when circumstances change.

Leaving pension pots invested and spending other capital first can be highly tax efficient.

Private life policies must be in trust, or they will be taxable, unless left to a spouse or civil partner. They can be used to pay the IHT due.

Business property relief is available after two years ownership. This includes certain shares listed on the AIM market and Enterprise Investment Scheme assets. Providing an individual can tolerate the additional risk involved with these investments, they facilitate a reduced IHT liability, while retaining access to the capital and any income they produce.

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