With careful planning it may be possible to reduce significantly the need for your estate to pay IHT. Here are five things to consider that can reduce your estate's IHT bill:
Many people are understandably concerned about giving money away during their lifetime. Unfortunately stockpiling wealth often results in a large charge to IHT following their death.
You can make gifts of up to £3,000 in each tax year without IHT consequences. Any unused annual allowance from the previous tax year can be carried forward for one year. This means that if you made no lifetime gifts in the 2018/2019 tax year, you could make gifts of up to £6,000 in the 2019/2020 tax year.
Lifetime gifts to individuals in excess of this amount do not immediately result in IHT becoming payable (they are known as 'potentially exempt') but the person making the gift must survive for at least seven years from the date of the gift for it to have no negative IHT consequences.
If your net income exceeds your annual outgoings, you may be able to give away the surplus income without any negative IHT consequences. This is a valuable (and often overlooked) exemption, which, unlike the annual allowance of £3,000, is only limited by the amount of your surplus income.
To benefit from this exemption you must be able to show a clear pattern of giving, rather than just an intention to do so. You must also be able to show that the gifts were made from income and that making the gifts did not result in a drop in your standard of living.
If the conditions for this exemption are met, qualifying gifts out of surplus income are immediately exempt from IHT and there is no need to survive seven years. Because of the more complicated nature of this exemption, good record-keeping is vital and you should review your finances regularly.
Unlike lifetime gifts, trusts give both control and flexibility. There are often good reasons why you may not wish to make lifetime gifts, such as having young children or grandchildren who are not yet financially responsible enough to receive significant sums of money. Trusts can allow you to maintain control of who receives money from the trust, at the same time as removing assets from your estate.
Trusts created during a person's lifetime are subject to a separate tax regime and IHT may be charged when the trust is created, as well as on each ten year anniversary and when assets are removed from the trust. Despite these charges, the rates of IHT that apply are lower than the 40% IHT charge that arises on death.
Trusts and their tax treatment can be complex and anyone wishing to set up a trust should take professional advice.
Pensions remain one of the most flexible and tax-efficient vehicles for saving and passing on wealth.
It is widely assumed that IHT does not apply to pensions. While this is often the case, to be exempt from IHT you should ensure that your pension passes outside your estate. The effect of this is that your pension fund isn’t payable to your estate; the trustees of the pension scheme have discretion as to who benefits (though in most cases they will follow the wishes expressed in any nomination form that you have completed during their lifetime).
If you do not give this discretion to your pension scheme trustees, or if your estate will receive your pension fund on your death, IHT is likely to be chargeable on the value of your pension.
Changes to the law now mean there are no negative IHT implications when a pension scheme member does not take up their pension benefits. However, IHT can arise when pensions are transferred and the pension holder dies within two years, or if a pension scheme member increases their contributions when in poor health.
Investment products are structured to have favourable IHT treatment, usually as a result of Business Relief, which can be an extremely valuable relief.
In addition to family-owned businesses, shares traded on the Alternative Investment Market (AIM) and Enterprise Investment Schemes (EIS) may be exempt from inheritance tax after they have been owned for at least two years.
The share prices of EIS and AIM shares can be volatile and whether the shares in a particular company will be exempt from IHT depends on the nature of the company itself. To avoid these potential pitfalls, many investment managers offer specialist AIM and EIS portfolios, which specifically include investments that will be exempt from IHT.
With all lifetime tax planning, it is important to start the process early and take professional advice.