Justin features in The Times' article on IHT planning
Confused by the technicalities of personal financial planning, I often receive calls from journalists looking for help with their articles. Last week, it was the intricacies of Inheritance Tax planning that stumped Elizabeth Anderson from The Times.
She was looking to use one of my YouTube videos on IHT as the basis of her article for Saturday's Money section, and decided to include some of the strategies that we use ourselves.
If you are a subscriber to The Times online, you can read the full article here.
Justin & Kathy’s IHT planning story
Justin, 53, runs his own company, MFP Wealth Management, and is already thinking about inheritance tax. He has taken out life insurance through his company so that if he dies sooner than expected Kathy, 49, will get a lump sum.
This policy is in a discretionary trust so the money is outside her estate, can be lent to her interest-free and repaid back to the trust on her death. It can then be left to their children, or grandchildren, without forming part of her taxable estate.
Justin also puts £40,000 a year in a pension, as does his wife, who also works for the business.
“Pensions provide a tax-efficient way of getting money out of our business to provide for our retirements. All the money is free from inheritance tax. Money in a pension also gets paid quickly after death, as long as you’ve specified on your policy who you’d like your pension to be paid to,” Justin said.
“I also have a trading business that would benefit from business relief. If I add my children as shareholders when they are 18 the business could be passed on to them inheritance tax-free [as long as the company is still trading on my death].
“I encourage my clients to give away money in their lifetime because you will see it enjoyed and appreciated. You won’t get that if you’re in a box — and the taxman may also have taken 40 per cent.
“From your eighties you’ll spend less than you think. There may be care costs, but the average care is about four years so may not require a huge amount of your savings.”
The Times: The Best Ways to reduce your Inheritance Tax bill
By Elizabeth Anderson, read the full article on The Times’ website here.
The money paid in death duties is up 30 per cent, mainly due to the rise in house prices, but making the most of gift allowances can greatly cut how much you will pay. Public finances may be under huge pressure with government borrowing at an all-time high, but the Treasury is, meanwhile, raking in a record amount from death taxes.
Inheritance tax (IHT) takings were £578 million in January, up 30 per cent on the year before. Most people will not have to worry about their families having to pay tax when they die — only 4 per cent of deaths involved an IHT bill in 2020, according to government data.
Yet with the thresholds at which you have to pay the tax frozen until at least 2028, it is likely to affect more and more families. And it is not popular: many resent that they cannot pass on assets to their loved ones without a possible bill.
So what are the rules, and how likely are you to have to pay IHT? Here’s what you need to know.
What is IHT?
Inheritance tax is charged at 40 per cent on the value of an estate over £325,000 (£500,000 if you leave your main home to a direct relative). Your estate is the total value of everything you own — properties, savings (excluding pensions) and valuables such as artwork or jewellery.
If your estate is worth less than what is known as the nil-rate band allowance of £325,000 you will not have to worry about inheritance tax. If you leave your home to a child or grandchild, your estate additionally gets the £175,000 residence nil-rate band.
Anything you leave to a spouse or civil partner is IHT-free and you can also inherit any unused IHT allowances from your partner. This means a couple has a total allowance of up to £1 million.
If your spouse dies and leaves you everything and you then leave your children an estate worth £1.5 million, they will get a £1 million allowance and have to pay tax on £500,000 at 40 per cent — so a bill of £200,000.
You start to lose the residence nil-rate band if your estate is worth more than £2 million — it is reduced by £1 for every £2 above £2 million and you lose it altogether if your estate is worth more than £2.35 million (£2.7 million for a couple where everything was left to the partner on the first death). So if you have an estate worth £3 million and are married the IHT bill would be £940,000. If you are unmarried the bill would be £1.07 million.
How much do you pay, and when?
If your spouse or civil partner dies, you can inherit their entire estate IHT-free. If you are in a couple but not married and your partner dies, you will have to pay IHT if you inherit their estate and it is worth more than £325,000.
IHT will be paid to HM Revenue & Customs (HMRC) by the executor of a will, using funds from the estate. If there is no will then the closest living relative can apply to be the estate administrator through the government’s probate service.
IHT has to be paid within six months of the person’s death. It can be paid directly from their account and is arranged by the executor or administrator filling out an HMRC Direct Payment Scheme form. If money is tied up in property that is not sold within six months, an executor can pay the IHT due and claim it back from the estate or you can arrange with HMRC to pay the bill in instalments, but the tax office will charge interest at 6 per cent.
You can take out a life insurance policy to give your family money when you die, which could cover IHT and make it easier for them to manage your affairs. You can either take out term life insurance to cover a specific number of years, or whole-of-life insurance, which will pay out whenever you die. If the policy is held in a trust, the payout would not be subject to IHT. The cost of whole-of-life insurance increases with age and poor health. Monthly premiums for whole-of-life insurance start at about £41 at age 30 or £62 at 40, according to the financial comparison site Unbiased.
The widening net
The nil-rate band has been £325,000 since 2009, when the average house price was about £178,000. It is now £294,000 and £404,230 in the southeast of England, so more families can expect to pay some inheritance tax.
If the threshold had risen with inflation it would be £474,716. The chancellor, Jeremy Hunt, has said he will not increase the allowance until at least 2028. The residence nil-rate band was created in 2017 and has not increased.
A total of £6.1 billion was paid in IHT last year and by 2027-28 this is expected to hit £7.8 billion, according to the Office for Budget Responsibility.
“Inheritance tax doesn’t just affect the super-rich. Rampant inflation, soaring house prices and years of frozen allowances will magnify the tax take. It will be the thousands of hardworking families that will bear the brunt,” said Alex Davies, the founder of the investment service Wealth Club. Some financial advisers and tax planners like to say that inheritance tax is voluntary — there are ways that you can reduce a potential bill.
There is nothing to stop you giving away assets or money during your lifetime. If you live for seven years after making a gift it will not be counted as part of your estate for IHT purposes. If you die within seven years the value of the gift may be added to your estate for tax purposes.
Every year you can give away £3,000 without having to worry about it having any IHT consequences. For example, if you have two children you might choose to give them £1,500 each year. And you can give as many gifts of cash or assets worth £250 as you like, as long as you haven’t used another gift allowance on the same person that year.
You can also give £5,000 to a child for their wedding, and grandparents can contribute £2,500. This can be given on top of the annual £3,000 exemption, so you could make an £8,000 wedding gift.
Donations to charities or political parties are also IHT-free, and if you leave 10 per cent of your estate to charity the level of IHT paid on the rest of your estate will fall from 40 per cent to 36 per cent.
Funeral expenses can also be deducted from the value of your estate. For example, an estate worth £800,000 would have a net value of £471,000 after the £325,000 allowance and the average £4,000 cost of a funeral were deducted. If £40,000 was left to charity, the remaining amount — £431,000 — would be subject to 36 per cent IHT tax, leading to a tax bill of £155,160 — a total of £195,160 paid including the charity donation.
Without the donation the tax bill would be £188,400 — £6,760 less and yet the charity would get six times that.
The rules also allow for you to make regular gifts from “surplus income” — as long as it doesn’t compromise your living standards. Keep records of your income and expenditure to prove that you have not been forced to dip into savings to cover everyday costs.
Pensions are not subject to IHT, which means you can pass them to a beneficiary and they would be taxed like any other income. It may make sense to spend any money you have in Isas or other cash savings first.
Other options
If you own a business you could make use of business relief, which allows a company to be transferred to family members or beneficiaries free of IHT.
Investing in companies that qualify for business relief also has benefits. You can invest in private firms or companies listed on the Alternative Investment Market and, as long as you have held the investment for two years when you die, they will be exempt from IHT.
If giving away money is not an option or you have a lot of assets, you could consider a trust. These are used if you don’t want to give money to someone directly, for example you want to give to grandchildren but don’t want them to access it until they are older. People generally choose discretionary trusts, which give trustees flexibility over who benefits and when. If you live for seven years after setting up the trust, there will be no inheritance tax to pay.
Trusts can be set up through solicitors or financial planners and you may have to pay a fee. Find a register of solicitors at sra.org.uk or an adviser through thepfs.org or unbiased.co.uk. It is up to the trustees to keep records and make sure that a trust is managed properly.