Ten tips for inheritance tax planning

Many more families may find themselves paying inheritance tax owing to tax threshold freezes. To help you make the best choices, here are ten tips to help with your inheritance tax planning.

| 7 min read

Feeling daunted at the prospect of managing an inheritance tax liability? You are certainly not alone. When planning inheritance tax mitigation, I think it’s always important to understand your current objectives and long term needs first, then address the tax implications.

Last financial year, HMRC received more than £7.1bn in death duties. Inheritance tax was originally deemed to only apply to the rich, but now a much greater proportion of the population is affected, after the threshold for paying the tax of £325,000 was frozen for longer until April 2028. If you’re wondering how to plan for inheritance tax, here are the most important things to consider.

Ten inheritance tax tips

1. Make a will and keep it updated

If you haven’t already done so it is vital that you make a will. A will forms a major part of your estate planning, as at the very least it will make sure that your estate is distributed in line with your wishes. If you do not make a will, your assets will be distributed according to intestacy rules and it may be liable to IHT that would be otherwise avoided.

2. Calculate the value of your estate

For some families this will be straight-forward, but there can be complications, for instance where assets are held jointly with others, gifts have been made in the past seven years or where there are business assets.

For higher value estates it is important to note that if you would normally qualify for the residential Nil-Rate Band but your combined estate is above £2.35m, is there any planning that can be done so that you do not lose this valuable additional band? This is why it is important to know the value of your assets!

3. Know your inheritance tax allowances and reliefs

Gifting rules allow £3,000 to be gifted each year free of inheritance tax - plus smaller gifts of £250 per person each year are allowed too. For any gifts above this amount, the seven-year rule applies – which means you must survive for at least seven years until these gifts are deemed to have avoided any IHT. If you die in the period, IHT is payable on a reducing scale.

4. Consider using trusts

Previously, trusts have been effective tools to pass on assets and mitigate IHT. However, rule changes have now brought further tax burdens on trusts and they are not as attractive as they once were. However, in the right circumstances, they can offer some effective planning.

5. Look at protecting your inheritance tax liability

It is possible to take out a life assurance policy that can protect against your IHT liability. As long as this policy is written into trust, it will not form part of your estate – leaving your executors in a position to meet the IHT bill. These policies are usually ‘whole of life’ and payable on second death for spouses, as generally, IHT is only payable when both have passed. This may allow you to avoid having to ‘gift’ parts of your estate, but they can be expensive.

6. Give money to charity in your will

Gifts to qualifying charities are exempt from IHT regardless of the value. In addition, if you give 10% or more of your net estate to charity, this will effectively reduce the overall IHT rate on your estate from 40% down to 36%. For many families with excess wealth, this can be an ideal way of reducing the tax burden and doing good as well.

7. Save into a pension plan

Most of us already have a pension plan via our employment and save towards our retirement. Pension funds including Self-Invested Personal Pensions (SIPPs) are not included in the calculation of IHT so they can be an effective way to save outside of the estate.

In some wealthy families, individuals do not need access to their pensions and so pass them onto future generations. The downside can be losing access to your fund, as withdrawals are not permitted prior to age 55 at present. Withdrawals above the pension commencement lump sum are taxable.

8. Set up a Family Investment Company (FIC)

Family Investment Companies (FICs) can also be used to assist in IHT planning and have become more popular in recent years, as rules surrounding trusts have changed. These can provide an excellent way of passing assets through the generations, as shareholders can be varied at any time. The downside is that they are taxed as a normal business under company law so large distributions, particularly in the early years, can be quite costly in the hands of the recipient. Successive governments may also change the rate of tax applicable and make them less attractive.

9. Invest into an AIM portfolio

AIM portfolios attract Business Property Relief (BPR) and, unlike a gift into a trust or to an individual, the assets are deemed to be ‘IHT proof’ after two years. The advantage of these portfolios is that the owner of the assets can recall them if needed in the future. You can also use your ISA allowance, which can help with any capital gains tax if a withdrawal is needed.

These portfolios are used predominantly by people in the latter stages of their life who take advantage of the shortened timescales involved. However, these types of investments carry a relatively high risk.

10. Spend all your money!

Spending any money above the nil-rate and residential nil-rate bands seem like the most obvious solution. However, this is simply not viable for most families, as we all need savings for unforeseen events including long-term care needs. Just owning your own home can use up most of the available NRBs, so giving away all of your other assets is not a good idea.

There are many different methods of completely mitigating or reducing your inheritance tax bill. However, many of these avenues may result in you losing control and access to your money, which is not advisable, particularly in your younger days.

That’s why it’s always important to focus on what your needs are likely to be throughout your life as well as your family’s. As a rule, you should consider your own needs first before conducting any serious inheritance tax planning.

When should I seek inheritance tax advice?

It's never too early to start planning, though most people begin thinking about IHT after the age of 55. Working with a good financial adviser and/or solicitor is important to fully explore your different options. Some couples decide to do nothing in their younger years, or just start the beginnings of an effective IHT reduction strategy. In many cases a variety of methods may be used to help mitigate IHT over the years. The most important thing is to be aware of your current situation and the options open to you longer term.

Inheritance tax can be an emotional subject, but there is support available. Have a conversation with a skilled financial planner to understand your potential tax liability and the steps to deal with it effectively.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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Charles Stanley is not a tax adviser. Information contained within this page is based on our understanding of current HMRC legislation. Tax reliefs and allowances are those currently applying and the levels and bases of taxation can change. Tax treatment depends on the individual circumstances of each person or entity and may be subject to change in the future. If you are in any doubt, you should seek professional tax advice.

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