Inheritance Tax - Passing on more of what you have

UK IHT liabilities climbed to their highest levels on record in the 2021-22 tax year, according to the most recent statistics from HM Revenue & Customs. IHT liabilities rose by £230 million, or by 4%, to £5.99 billion compared with the previous year.

HMRC said that the rise was driven by increased asset values and the previous government’s decision to freeze the tax-free threshold, rather than increasing it in line with inflation.

Whilst only a small fraction of estates in the UK pay Inheritance Tax (IHT), for those that are liable it can significantly impact the amount beneficiaries receive.

Who pays IHT?

IHT primarily impacts individuals with significant assets. Estates that exceed the nil-rate band (currently £325,000) and the residence nil-rate band (a potential further £175,000 for those passing on a family home to direct descendants) will pay IHT at 40%.

As assets transferred between spouses on death are not subject to IHT, and each individual has their own nil-rate band and residential nil-rate band, when it comes to couples, the value of the estate has to exceed £650,000 before IHT is considered, and potentially £1 million where there is property involved.

However, given the steady rise in property prices and asset values, this threshold can easily be breached meaning many who would not traditionally consider themselves wealthy may find their estates subject to IHT.

Should anything be done?

The first step is to understand if you have an IHT liability in the first place. Though on the face of it this might seem like a relatively simple exercise, the rules around the allowances, what assets form part of your estate, and which of those might be taxable are complex so we would always encourage seeking professional advice. For example, many people forget that (usually) pensions sit outside of their estate for IHT purposes and therefore can be discounted. Conversely, whilst there is 0% IHT on investments that attract Business Relief, they do still form part of your estate and therefore can impact the residential nil-rate band.

Once you know the value of your potential IHT liability it is worth considering what this is as a percentage of your total estate and how much your beneficiaries will actually receive. Whilst the headline rate for IHT is 40%, after accounting for allowances and non-IHT assets, the amount of IHT paid as a percentage of the total estate is usually much lower.

For example, a couple with a property worth £1.5 million, £500,000 in ISAs, and £1 million in pensions will pay £400,000 in IHT, which is approximately only 13% of their total estate and their beneficiaries will still receive £2.6 million.

Armed with the above information, you can now make a more informed decision as to whether you want to take any action. This will be informed by several factors, mainly the size of your inheritance tax liability, your age, and your inclination towards paying IHT.

What can be done to reduce your IHT liability?

• Though relatively modest, utilizing the annual exemptions and reliefs can add up, so it is important to take advantage of these. Most notable is the annual gift allowance of £3,000 per year and the small gift allowance of £250 per person, both of which allow for tax-free transfers during your lifetime.
• More significantly, outright gifts of any value during your lifetime can be an effective way to reduce your IHT liability. Gifts made more than seven years before death are generally exempt from IHT so, if you are in a position to give up control and will not require the capital in the future, this can be a highly effective way to reduce the size of your taxable estate.
• Another way to gift but still retain control of how assets are used and distributed, is by placing them into a trust. Trusts can be a powerful tool to manage how and when beneficiaries receive assets whilst also potentially reducing the IHT burden. However, trusts come with their own tax considerations and should be used with professional advice.
• Investments into business relief can attract 100% relief from inheritance tax (subject to holding them for a certain period, 2 years in most cases). Agricultural relief assets can also qualify for 100% relief (subject to qualifying criteria). So, both can offer a relatively quick way to reduce an IHT liability for those that have the appropriate risk profile and capacity for loss.
• Finally, an often forgotten yet highly effective solution is taking out a life insurance policy specifically designed to cover IHT liabilities. There is the added benefit that your estate is not forced to liquidate assets to pay the tax and can be particularly beneficial for those who have high cashflow that is building up in their estate, and therefore can afford the often high premiums.

For most individuals, the optimal strategy will include a combination of the above and this will be dependent on their financial position, risk profile, inclination, and ultimate object when it comes to IHT planning. Given this is a complex area of financial planning, we would always encourage seeking advice before taking any action.

What does a change in government mean for the future of IHT?

With the recent election of a Labour government, the landscape for IHT may be set for change. The new government has signalled its intent to increase tax revenues so that it can better fund public services, and with increases in income tax, national insurance, and VAT currently ruled out, IHT is a likely target.

There are many ways they could do this, but the potential changes could include:

• Lowering the nil-rate band or even residential nil rate band to increase the number of estates liable to IHT.
• Abolishing or reducing reliefs on certain investments.
• Increasing the rate of IHT or even introducing higher bands for larger estates.

As we near the Autumn budget (30th October 2024), potential leaks might give an insight as to the expected changes but at this stage it is difficult to predict, and we would warn against taking action based on speculation.

Regardless of whether any changes are made in October, we would always encourage those individuals who are later in life to review their IHT position and wills every couple of years and seek professional advice should they have any questions or want to take action.

If you would like to discuss any of the above further, please contact your wealth manager here, or email us here.

Written by Jonty Brooks