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Planning for a tax-efficient generational wealth transfer

Tax has featured heavily in the news recently. Hardly a month goes by without reference to the increasing overall tax burden, which is unsurprising given the exceptional events the world has experienced over the past three years.

| 7 min read

Governments have provided significant financial support to businesses and individuals through the pandemic, the energy-price spike, and the cost-of- living crisis. They are now focusing on balancing the books and returning to greater fiscal discipline.

The headlines in relation to tax rises tend to focus on areas such as Corporation Tax, Capital Gains Tax, and the freezing of Personal Allowances. Whilst it might not attract as many headlines, Inheritance Tax (IHT) has quietly been gathering increased revenue for the UK Treasury and is forecast to continue in an upward trajectory for the foreseeable future. In this article we’ll take a look at IHT as a tax, its evolution, and planning strategies that can be used to mitigate the effects of it.

IHT doesn’t tend to hit the headlines because it doesn’t affect the majority of estates, but with significant growth of property and other financial assets over the last 40 years, it has started to impact more and more families. The latest figures for IHT were released in February and show the Treasury collected £6.4bn between April 2022 and February 2023. This already exceeds the total £6.1bn in IHT collected for the 2021/22 tax year – and we still have the March figures to come.

The Treasury-funded Office for Budget Responsibility revised its projection for IHT tax receipts as part of its forecasting for the recent Budget. It predicted HMRC might collect almost £3bn more over the next five years than previously estimated. The roots of IHT can be traced all the way back to 1694 when a “Probate Duty” was introduced on all estates valued at more than £20. This duty was fixed at a rate of 5 shillings. The concept of IHT or Estate Duty, as it’s also been called in the past, has evolved over time to tighten up loopholes and reflect the ever more complex financial landscape. Major reforms were made in the seventies and eighties by both Labour and Conservative Chancellors.

A new millennium brings some respite

All went quiet on the IHT front until 2007 when the fixed exemption allowance on the first £325,000 of an individual’s estate was introduced, along with the ability for married couples to inherit their partner’s exemption. The most recent change came in April 2017 when an additional allowance was introduced for homeowners which currently adds a further £175,000 for each partner. This potentially gives married/civil partner couples a total of £1 million exemption from IHT.

A financial planner using financial forecasting software can establish your position now, and at the point where IHT is most likely to be paid, based on measured assumptions and life expectancy estimates.

However, the homeowner exemption tapers away for estates with a value greater than £2 million. For every £2 of value above £2 million, the additional allowance is reduced by £1, meaning an estate of £2.35 million would see the additional exemption lost completely.

How does this help with estate planning?

The starting point is to establish the size of the liability both now and projected forward to the date of your expected longevity. A financial planner using financial forecasting software can establish your position now, and at the point where IHT is most likely to be paid, based on measured assumptions and life expectancy estimates.

Once we know the potential size of the challenge, we can begin to consider the actions we could take to mitigate the liability. This could involve several planning strategies such as gifting assets, setting up trusts or investing in assets that benefit from a form of IHT exemption known as Business Relief – or a combination of more than one method.

Before deciding what options are suitable for your circumstances your financial planner will take time to understand your wider needs and objectives for your financial assets. For example, large financial commitments that are planned, income requirements, and ensuring a provision for potentially expensive care fees in later life. Once the bigger picture is known, the detail can then be considered, and this will involve a number of factors depending on individual circumstances, the balance between access and control of assets, the need to generate income, and family dynamics.

Using gifts and trusts

You could simply make outright gifts during your lifetime. There are a range of relatively modest gifts that are immediately treated as outside of your estate. Everyone can gift £3,000 per tax year in this way, and there are other exemptions such as gifts for weddings and small gifts of below £250, which can be made without limit, providing they are to different people and those recipients haven’t benefitted from any other gifts from you in the same tax year.

There are other methods of achieving IHT relief without losing control of your assets, such as placing funds in a Gift and Loan Trust.

Making regular gifts out of excess income is also allowable and results in the gift being immediately outside of your estate for IHT purposes, although it is important to keep good records of these gifts and ensure that you can demonstrate the income is genuinely surplus to your requirements.

Certain types of trusts can result in the capital being removed not only potentially from your estate for IHT purposes, but also from your control. This is why it is crucial to account for all eventualities before determining whether this course of action could be taken without any future detriment to your lifestyle. To successfully remove capital from the IHT net, you may have to survive a period of up to seven years beyond the inception of your plan. You should also consider the impact of gifting larger amounts in terms of what may happen if a recipient were to go through a divorce and how the gifted asset may be distributed in this event.

Some more flexible approaches

There are other methods of achieving IHT relief without losing control of your assets, such as placing funds in a Gift and Loan Trust. You can still access the original capital sum and it is still part of your estate for IHT but any growth or income received by the investments is immediately excluded from your estate for IHT purposes.

There are other methods that achieve relief in a shorter time frame. An example of this is investing in assets that qualify for Business Relief. Not only do you retain ownership of the assets, but IHT exemption can be achieved in just two years rather than seven. However, these assets are considered higher risk and you would need to be comfortable that you could tolerate the associated short- term losses. This would be something to discuss in detail with your financial planner prior to making any decisions.

In summary, IHT is a tax that although not widely publicised, is growing and affecting many more families. The area is complex and careful planning is required to ensure all options are considered. Financial Advice should be taken before arriving at a suitable course of action.

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.

Planning for a tax-efficient generational wealth transfer

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