Inheritance Tax Planning - What Are Your Options?

If you've identified that an Inheritance Tax liability could apply to your estate, and have had this confirmed by a financial professional, the next step will be to consider the options available to you. As an Independent Financial Adviser I will be able to guide you through each of these. I cannot stress the importance in seeking advice early on, to better ensure that your objectives can be met, and to seek professional advice to ensure the recommended course of action is appropriate to your financial objectives.

What Options Are Available?

The options available to you upon identifying that your estate gives rise to an Inheritance Tax liability can be captured under 5 main headings; 'Do Nothing', 'Gift', 'Insure', 'Trust' and 'Business Relief'. Here I will cover what each of these mean. 

Do nothing - this is the simple option and the cheapest, but will have no benefit to the beneficiaries of your estate in the long run and could end up leaving them with a hefty tax bill.

Gift - there are annual allowances and certain events which allow you to gift from your capital, which will help to reduce the value of your estate for Inheritance Tax.

Everyone has an allowance of £3,000 per tax year, which they can gift. If you don’t use this allowance one year, you can carry it forward to the next tax year, but you can only carry it forward once - if you don’t use it in the following tax year then you lose it.

In addition to the £3,000 annual exemption, wedding or civil ceremony gifts of up to £1,000 per person are allowed. This is increased to £2,500 if the gift is to a grandchild or great grandchild, or £5,000 if the gift is to a child, on their wedding or civil ceremony.

Gifting surplus income is also allowed, provided you are able to maintain your standard of living after making the gifts from your regular income, as are payments to help with another person’s living costs, such as an elderly relative or a child under 18.

Small gifts of up to £250 per person are permitted, to as many people as you like, provided you have not used another exemption on the same person in that tax year.

Finally, gifts to charities and political parties are excluded from any Inheritance Tax calculation.

Any other gifts that you make, that do not fall under the exceptions mentioned above, will continue to form part of your estate for Inheritance Tax for 7 years after the date of making the gift, and maybe even longer under some circumstances. They are referred to as PET’s (Potentially Exempt Transfers). A clock will begin ticking when you make the gift, and provided you survive for at least 7 years following the year in which you make the gift, no Inheritance Tax will be chargeable on that gift. Inheritance Tax on non exempt gifts made during the 7 years prior to death is charged on a sliding scale, this is known as taper relief - gifts made in the 3 years immediately before death are charged at the full rate of 40%, but gifts made 3 to 7 years before you die are taxed on a sliding scale of between 32% and 8%.

It’s a bit of a gamble, particularly for gifts of a significant value, which is why some people choose to take out insurance, to cover the potential liability over a term of 7 years. Which leads me on nicely to discuss utilising insurance as a means of covering an Inheritance Tax liability.

Insure - once you have an idea of the potential Inheritance Tax liability likely to be due on your estate, based on the value of your assets, you may wish to take out a life assurance policy. For a married couple, the policy would be taken out on a joint life, second death basis - the reason for this is that there would be no Inheritance Tax liability on first death, provided most assets pass to the surviving spouse, and so the insurance proceeds are needed on second death. The insurance provides the beneficiaries of the estate with the money needed to pay the Inheritance Tax liability. It’s important that any such life assurance policy is written in Trust, as not doing so would only exacerbate the situation.

Depending on age and health, this could be an expensive option and some insurers may even decline to offer cover. Therefore, it’s not always a feasible option for everybody, but it does allow you to retain control and access to all of your assets and not worry about how your beneficiaries are going to find the money to pay the tax bill once you’ve passed away. Insurance should be reviewed regularly and the cost of such a plan could increase substantially.

Trust - there are various Trust schemes available for use with Inheritance Tax planning.

Loan Schemes work by ‘loaning’ a sum of money to a Trust. The capital will always belong to the person that lent the money to the Trust, so it’s value will remain within the estate for Inheritance Tax purposes, however, any growth on that money sit in the Trust and will therefore fall outside of the estate. This type of scheme is a means of helping to prevent an Inheritance Tax liability from increasing, or even to prevent a liability from occurring in the first place. Usually the loan can be recalled at any time by the donor, so it can be useful in situations where future capital requirements are uncertain, for example, to pay for care.

Gift Schemes are exactly what they say on the tin - a gift is made into the Trust. This means that the individual loses future access to that capital and as such it will fall outside of their estate for Inheritance Tax, but only once 7 years have passed. As the gift is made into a Trust, there is more control over when the beneficiaries can access the money, which is what differentiates this option from just making an outright gift to the chosen beneficiary.

Discounted Gift Schemes pay a regular income to the settlor (the individual who created the Trust and paid the money into the scheme) and reduce the value of the estate for Inheritance Tax. The way in which a Discounted Gift Scheme works is through a combination of ‘gifting’ a lump sum and ‘ring fencing’ capital for the provision of the income. The capital that’s been ‘ring-fenced’ is the amount of the ‘discount’ and is based on life expectancy, so in theory a younger person would have a greater ‘discount’ than an older person, because more capital would need to be set aside to provide the income payable for the rest of their life. The capital that’s been set aside to provide the regulator income remains in the individual’s estate, but the balance of the investment is treated as a gift and therefore subject to the same 7 year rule mentioned above.

There are different types of Trust that can be set up to hold assets, with the aim of passing those assets on to future generations smoothly and efficiently. Professional advice should always be sought on the most appropriate type of Trust for your circumstances and objectives. This article is based on my understanding of Trusts. Rules and legislation are subject to change, so there is no guarantee that a Trust will fulfil it's original objective, and Trusts can prove to be very inflexible i.e. if you change your mind.

Business Relief - There is one other solution which allows you to continue to have control over your money and have access if you need it.

Business Relief was introduced in 1976 to allow businesses to be passed on to the next generation free from Inheritance Tax.

You may be wondering why the Government are prepared to honour this generous tax relief, and maybe you are thinking that there must be a catch, right? Well, what if I was to tell you that Business Relief supports small and medium-sized enterprises (SME’s). 85% of businesses in the UK are family owned and the family business sector in the UK employs over 13.4 million people, generates a quarter of GDP and in 2017 paid £182bn in tax (source: www.ifb.org.uk). Now it begins to make sense... an investment into these types of businesses is supporting the UK economy and generating more tax for the Government through growth in those UK companies.

The attraction of Business Relief qualifying investments is that not only do they give your capital the opportunity for growth and support small and medium-sized family-owned businesses in the UK, but they become exempt from Inheritance Tax after being held for just 2 years.

This means that you can invest a lump sum into a Business Relief qualifying investment and after 2 years, provided the investment is still held on your death, the beneficiaries of your estate will inherit that investment and will not need to pay Inheritance Tax on it’s value. Most providers of this type of investment allow you to access your money if you need it, and some have the facility to pay you a regular income from your investment.

If you’ve sold a business within the last 3 years, rules allow you to reinvest all or some of the proceeds from that sale into a Business Relief qualifying investment and that capital would become exempt from Inheritance Tax from day 1.

Due to the nature of this type of investment, this is considered high risk - your capital is at risk.

The purpose of this article is to provide an overview of the options available when considering Inheritance Tax planning and is based on my understanding of the rules, regulations and Government legislation, which is subject to change. It should not be construed as advice. A full analysis of your current circumstances and objectives would need to take place before any recommendation could be made.

If you feel you may benefit from a review of your financial circumstances, please contact me, I’d be happy to help.

Charlotte Owen