Inheritance Tax Planning

October 30, 2020 – Written by Sam Ratnage

During the past few months, as the world battles with the effects of Covid-19, you will have seen regular investment updates assessing the impact on the general economy and investment markets illustrating how that feeds into Tideway’s philosophy, expertise and ultimately how we manage our client’s money. This has proven to be a great way to communicate with our customers, putting complex subjects of high interest into a much more palatable simple context, hopefully giving customers some comfort on their future and their money, whilst negative news travels throughout the world from our easily available media sources.

This note is the start of a regular financial planning update which will hopefully illustrate to you our other expertise that can have a significant impact on your family wealth. Good clever financial planning may not be as well published but is a way of seeking to make actual financial gains without the risk and worries of the investment markets. Our team of financial planners have a breadth of experience and will be covering a number of different topics and areas over the coming months where our expertise can help individuals make good decisions on what to do with their money for their family.

Today I will be talking about Inheritance Tax (IHT) which can often be a subject hard to discuss with family members, not only because of the morbid nature of it but also due to the complexity.  Whilst you are in good health, it is often a subject that can be discussed in the future.  Your estate, which is effectively everything you own of value, is potentially subject to IHT at 40% before it can pass down to the next generation. However, there are some exemptions; most notably, the nil rate band, which is currently £325,000 and providing your wealth is below £2M, an additional £175,000 against your main property, known as the residential nil rate. It is also worth noting most pensions are not regarded as being part of your estate, but not all.  In short, each individual’s estate can be exempt from IHT up to £500,000 and for a married couple this can be up to £1M of assets. Unused nil rate bands can be passed to a surviving spouse without being tested for IHT. Anyone with assets worth over £2M will start to see their exemptions reduce back to £325,000 per individual as for every £2 over £2M your residential nil rate is reduced by £1. Everything over the nil rate bands is likely to be charged at 40%.

To put this into context a married couple worth £1.4M through a mixture of property, savings and investments will have an inheritance tax liability of £160,000 and a married couple worth double, i.e. £2.8M will have an inheritance tax liability of £860,000. On second death this tax has to be paid to HMRC before funds can be passed to the beneficiaries, in most cases the next generation.

 Married couple worth £1.4MMarried couple worth £2.8M
Exemptions to IHT£1M£650,000
Amount liable to IHT£400,000£2.15M
Inheritance tax liability at 40%£160,000£860,000
Percentage of wealth payable to HMRC on second death11.4%30.7%

Historically, there have been three main ways to mitigate an IHT risk: spending it, gifting it or protecting against it. Gifting money to beneficiaries is the easiest way but the hardest question is when? Gifted money remains in your estate for seven years. Do it too early and you have lost control of it when you may still need access to it in 10/20 years’ time. Leave it too late and it still remains in your estate for seven years. Not gifting it completely means it maybe regarded as a gift with reservation and so never leaves your estate. There are however a few different solutions to reduce those seven years or help you continue to remain in control of your assets that Tideway can help you with.

For example, you can invest into certain investments which effectively reduces the seven-year window down to two years. This works well for someone in their late 80s who might feel it is too late to gift the money but, depending on their attitude to investment risk, can invest in areas such as renewable energy, infrastructure and other asset backed investments. They also maintain control of the asset and so if they do need this money, they can draw on it. It is worth noting that these investments whilst they can be asset backed are of a higher risk nature and not suitable for all.

The other option is a trust approach, where money can be placed into a trust by someone whilst they are fit and healthy and the seven year clock started, the trust can be invested into a much wider range of assets and so doesn’t necessarily have to be of the higher risk nature, but the donor to the trust can maintain control and decide when it is the right time to release the money to the beneficiary. There are numerous different types of trust with different taxations, rules, pros and cons to consider, so understanding of the trust and the personal circumstances should be taken into account. 

Going back to the original example with the married couples; the first couple worth £1.4M could place £400,000 into approved investments or a trust and as long as they survive the associated time length can save £160,000 in tax for their children/grandchildren.

 No ActionSensible Planning with £400,000
Available Capital to donor£1.4M£1.4M
Additional capital available to Family£0£160,000

Whilst the above examples are based on current tax rules, which can be subject to change, the financial gains of sensible planning can be quantified in pounds and pence immediately and will not be subject to future expectations like the investment markets.

If you are interested to know more about your inheritance liability and doing something about it or even an elderly family member’s inheritance tax liability, do get in touch with your Wealth Adviser or book in an initial free of charge session with one of our Chartered Advisers who will happily talk you through the rules and options. At Tideway we have a number of experienced Chartered Financial Planners and Wealth Advisers who can work together for you and find an appropriate solution based on your personal circumstance.

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