Inheritance Tax discussions with our clients have brought about views from both ends of the spectrum. We often hear these two contrasting comments:
‘however much my kids get it’s a damn site more than I did so I’m really not bothered’
‘we worked hard all our lives to build up our assets and cant stand the thought of a huge chunk disappearing in tax’
There are others with far too many expletives to repeat!!!!
If your views on Inheritance Tax are aligned with the first comment you will like strategy 1. Otherwise you may find other strategies of more interest.
In percentage terms. compared to Income Tax and National Insurance, the tax take the UK government receives from Inheritance Tax (IHT) is relatively small, the actual amount has for the first time exceeded £5bn in the 2017-18 tax year.
Leaving aside any changes to rates of taxation or allowances on IHT or Capital Taxes in general (watch this space if we get a change of government, or even if we don’t!) this looks set to rise anyway, largely due to house prices rising at a higher rate than the inheritance tax thresholds.
Once famously described as a largely voluntary tax, there are ways to ensure the effect is minimised and as much of your wealth is protected to be passed down the next generations, or to those closest to you.
1. Spend it. If you are not too bothered about how much money passes to the next generation. In theory, the best form of inheritance tax planning is ensuring your last cheque bounces! Engaging in the financial planning exercise helps a lot with this and will identify when surplus capital and/or income are starting to build up.
The real difficulty with this strategy is not knowing when we are going to die and therefore the fear that we might run out in later life hampers and restricts our ability to spend.
2. Give it away. Making gifts during lifetime can help reduce the value of the estate on death. Many people are aware of the 7 year rule, where with certain gifts you need to survive 7 years for them to fall outside of your estate for inheritance tax purposes.
However there are many other gifts that are immediately outside your estate. These are either within certain allowances such as the annual £3,000 gift allowance, or the unlimited small gifts of £250. Gifts on marriage, (depending on the relationship with the bride or groom) also qualify. Gifts out of regular income can potentially be immediately outside the estate and can be quite substantial depending on income levels. Finally any gifts to charity or political parties (if you are that way inclined) are also immediately exempt.
3. Protecting against it. Having a life assurance policy that pays out an additional lump sum, (via trust to your beneficiaries) equivalent to the amount of Inheritance Tax due, means that while the tax is still paid, your beneficiaries have additional resources to pay it quickly without having to sell assets, and the rest of your estate is kept intact. One issue with this strategy though is that life assurance becomes more expensive as we age, and as health issues start to materialise. Having said this, it is not uncommon for adult children to pay the premiums, as at the end of the day it can be in their interests to protect their inheritance.
4. Mitigate against it. There are certain ways you can mitigate against inheritance tax. This might include investing in assets that qualify for exemption, such as Business Property Relief or Agricultural relief. There are also special types of trusts where either the growth on the investment is outside the estate or there is an immediate discount on the value of the gift. This can work depending on individual circumstances.
5. Do nothing! It is a valid option, and one that some clients take. The premise often being we came into this world with nothing, paid taxes all our life, and therefore if we need to pay tax on our death there is still a net gain over our lifetime.
Rarely will one solution solve the problem, and often a combination of the above strategies will need to be employed to achieve the desired outcome.
Engaging in the financial planning process is the first step to addressing concerns around potential inheritance tax. This will not only highlight the current liability, but will also predict the likely affect this might have on your estate into the future.
Furthermore, the financial planning process will provide clarity around whether further spending or lifetime gifts are affordable, and therefore a valid option based on your circumstances at this particular stage on life’s journey. This is vitally important as ultimately it should be a balance between living the life you desire to its maximum potential and protecting your accumulated wealth for future generations.
One last comment on the subject. Irrespective whether inheritance tax may become due, is to ensure that your wealth passes safely to the people that you intend to receive it, in the proportions that you wish. So an up to date will is paramount, together in some cases with the establishment of trust arrangements and these should be regularly reviewed.
If you would like to discuss your estate planning requirements and protecting the wealth you have worked hard to accumulate, please do get in touch.