Our financial planner, Ross Glanfield, discusses things to look at when considering the impact Inheritance Tax (IHT) will have on your financial plans.

Having spent a lifetime accumulating assets out of taxed income and paying tax on interest, dividends and capital gains, the final insult is surely a demand from HMRC for 40% of the value of your taxable estate at a time when your family least need it.

Official figures show that Inheritance Tax (IHT) raised over £5.3Bn for HM Treasury in the 2019/20 tax year, and this is forecast to rise to £6Bn this tax year. This is a significant figure for what is essentially a voluntary tax.

Of course, no tax is truly voluntary. Unlike other taxes, however, with a little planning, it’s possible to organise your estate so that most of it passes to your beneficiaries rather than being used to pay off the (not inconsiderable) national debt.

Dealing with estate planning is naturally a difficult and emotional subject. It means contemplating your own mortality, that of a partner and, perhaps also giving up control and/or ownership of some of your assets. It’s important, therefore, to take a logical approach, consider all the options and blend this with your overall retirement strategy.

The basics of IHT are relatively simple. Everyone has a nil rate band of £325,000 (frozen at this level until at least 2026). Those with estates of £2m or less can also qualify for up to the full residence nil rate band (RNRB) of £175,000 (if the estate is above £2m the RNRB is reduced or lost). Both allowances can be transferred between spouses/civil partners, so it pays to be married or in a civil partnership just before you die. It also pays to make a will as the RNRB is only available where estates pass to direct descendants. Estates valued over these allowances have the excess taxed at a flat rate of 40% (or 36% if at least 10% of the net estate is left to charity).

The traditional method of IHT planning is to take out a life insurance policy and place this in trust to pay the tax. Thus, the estate would be left intact. The difficulty is that, since most of us don’t know when we’re going to die, it becomes necessary to buy a whole of life insurance contract, which will pay out whenever this occurs. Whilst these can be expensive, insurance policies are an effective planning tool if you want to retain control of your estate.

Another option is to gift your estate during your lifetime. Everyone has an annual gifting allowance of £3,000 (plus other small gifting allowances) but, using only this, it would take more than a lifetime to gift a reasonably sized estate. Gifts out of disposable income are also immediately exempt but this too is unlikely to make a significant dent in the liability for most estates. Gifts over the allowance become PETs (Potentially Exempt Transfers) or CLTs (Chargeable Lifetime Transfers) and these only fall outside an estate in their entirety after seven years have elapsed. 

The main problem with gifting is that, if the gift is to be effective for IHT purposes, the donor cannot benefit from the gift i.e., it’s not possible to give away an investment portfolio and retain the right to the dividends. So, if you give money away, make sure you can afford to do so.

Gifts can also be made into a trust. The problem here is that gifts over the IHT nil rate band into discretionary trusts attract an immediate 20% tax on the excess and then the trust can be taxed at 6% every 10 years on the excess over the nil rate band. There is also an administrative burden with trusts: many now must be registered, with the possibility of having to submit an annual tax return for each trust.

The problem many people face with IHT planning is that they leave it too late. If an individual loses mental capacity, their affairs need to be managed under a Power of Attorney. At this point, the law states that the attorney can only make gifts from a person’s estate of very limited amounts to family, friends, and acquaintances on customary occasions. Small gifts to charity are also allowed. Nor can the attorney put monies in the trust without permission from the Court of Protection. In this instance, there is often only one solution for IHT mitigation.

Business Relief (BR) was introduced in 1976. It ensures that a shareowner in a qualifying business will not be taxed on death on the value of that asset. So, if an individual buys shares in a business that qualifies for BR and holds those shares for 2 years, that asset may qualify for 100% relief from IHT. 

Over the last decade, BR funds have become mainstream with investments into renewable energy, commercial and property lending, forestry, reserve power, AIM shares, fibre-optic broadband and even golf courses. These types of investments are not without risk and the fees to access such markets are much higher than for standard retail investments. However, the track records for preserving capital and delivering both returns and an IHT mitigation strategy have so far generally been good. 

Nonetheless, this strategy needs careful consideration. The attorneys need to act in the best interests of the client. They need to ensure that income and capital needs are met before any estate planning is considered. There is a risk too, should the client not live for two years after making the investment, the underlying strategy fails or there is a change in the political landscape. Where the estate is substantial and the risks can be accommodated, this area is certainly worth consideration.

For the right investor, there is no reason why these strategies cannot be employed as part of a balanced portfolio within the overall retirement strategy and before a power of attorney is needed.

If you think you have paid enough tax during your lifetime and you would rather your estate is passed to your family rather than to HM Treasury or a charity, please get in contact. I can help you consider all your options and put a plan together.

LIFT-Financial are authorised and regulated by the Financial Conduct Authority. The Financial Conduct Authority does not regulate Wills, Trusts, Tax or Estate Planning.