Financial planning - Inheritance

I specialise in helping individuals and families with Inheritance tax (IHT) advice and the benefits and uses of family Trusts. As well as having the potential to eliminate or reduce Inheritance tax, a family Trust can also have other positive benefits such as planning for long term care fees and simplifying and reducing the administration of probate on death.

In my 25+ years of experience of helping and advising clients, it is often misunderstood that an up to date valid Will does not mitigate the Inheritance tax problem. A Will is merely your dying wishes, sometimes, without further professional advice and planning, those wishes may not come true.

A Will addresses the assets that are within your estate. However, if an asset is in your estate, it is vulnerable to Inheritance tax. A Trust fund is a legal legitimate way of removing assets to outside the estate, where they become less vulnerable, but you still have control of the asset by acting as Trustee of your own Trust fund.

If you want your family to keep more of your estate when you die, then there are some simple ways to reduce the amount of IHT that will be due.

Despite the fact that more estates are paying Inheritance Tax (IHT), relatively few people understand the rules, and even those who do often forget or ignore ways to prevent their families paying over the odds. So, here’s a reminder of some IHT-reducing strategies to think about as we approach each tax year.

1. Give to family members – providing they actually need the gift…

One of the easiest, and potentially rewarding, ways to reduce a future IHT bill is to give some of your wealth away during your lifetime. You can give away up to £3,000 each tax year and not have to pay IHT on it. You can also make use of any unused gifting allowance from the previous tax year. So, a couple could potentially remove £12,000 from their joint estate before 5 April. Remember that last year’s allowance will be lost after that date.

The gifted money could be invested on behalf of a child or grandchild. For instance, you could contribute towards a child's Junior ISA, which could give them a head start and get them into the savings habit. The most that can be saved is subject to a £9,000 limit in the 2020/21 tax year – an allowance that will be lost after 5 April.

You could also think about using the money to boost a child's retirement prospects. You can pay £2,880 a year into a child’s pension in the 2020/21 tax year, and this will be grossed up to £3,600 by basic rate tax relief. Non-taxpayers cannot carry forward unused allowances, so this year’s opportunity will also be lost unless action is taken before the 5 April deadline.

Additionally, the recipient - your loved ones, may need the gift for help with buying a car, deposit for the first home or university fees. However, if you are just gifting without a need, other than to try and reduce your own Inheritance Tax bill you must be aware of the consequences of ‘out-right gifting, without reason’

  • You will have increased the recipients estate and possibly caused them to have their own IHT liability
  • You have lost control and ‘say’ over the asset and its value
  • The asset is vulnerable to divorce law within the recipients estate
  • The asset is vulnerable to bankruptcy legislation within the recipients estate

Subsequently, before gifting, seek advice and ensure that you understand the benefits, consequences and risks of Gifting. You are able to gift into a Trust fund rather than direct to an individual and have the peace of mind that the above 4 consequences do not apply to gifting in certain trusts.

2. Make gifts out of income

Those with sufficient surplus income may want to take account of the ‘normal expenditure out of income’ rule – if you make regular gifts out of income and in doing so don’t affect your standard of living, they are exempt from IHT. This exemption is only limited by your personal resources and the amount of spare income available to give away.

Keeping a record of who you made the gifts to, their value and the date they were made, should speed up the process of any checks made by HMRC. You could also consider establishing a standing order (e.g. to provide funds to pay for grandchildren’s school fees) as it supports the intent to make the gifts on a regular basis. If you can satisfy the conditions for the exemption, the gifts escape IHT as soon as they are made.

However, you do not have to gift surplus income to an individual, you can use a discretionary trust fund and retain control over the funds, distributing the accrued capital when you and the additional Trustees agree that it is an appropriate time in life for the beneficiaries to receive all or some of the proceeds within the Trust.

3. Place assets into trust

Assets that are placed into trust will be outside of your estate, provided you usually survive for seven years. Should you die before this time has passed your estate will potentially incur Inheritance Tax. So the use of trusts can potentially reduce an IHT bill. You can set up a trust right now or write one into your Will.* The rules are complicated, and there are anti-avoidance rules that must be navigated, so you should take advice from an expert who specilaises in this area of Financial planning.

It gives me and my clients a great deal of satisfaction to see the benefits and support that this area of planning produces for the whole immediate family and beyond.

Depending on the client's circumstances, aspirations, needs and goals, there are some Trust funds that can give immediate Inheritance tax savings rather than having to wait for the usual 7 years survival from gifting. Additionally there are solutions not involving trusts.

Often there is not just one solution that completely takes care of the Inheritance tax problem. This is where professional bespoke advice is needed and the adviser understanding what the client wants and needs. A combination of solutions can be used for the client to enjoy or distribute during their lifetime, but with the peace of mind of knowing that their Will is effectively armour plated with these extra steps of professional planning.

4. Save more into your own pension

Saving into your own pension will avoid IHT at 40% on the invested funds which could be incurred were the same funds held elsewhere in your estate. This is because anything left in your pension can usually be paid as a lump sum or income to any beneficiary with absolutely no tax to pay if you die before the age of 75. If you are 75 or over when you die – and that is likely to be the case for most individuals – your heirs do pay Income Tax, but only when they take the money out. Even then, the tax is paid at their own marginal rate. So, maximising this year’s annual pension saving allowance should be on your list of potentially worthwhile estate planning options.**

5. Review your Will

Who you leave money to in your Will might affect whether or not IHT is payable. For example, money or property left to a spouse or registered civil partner does not attract IHT. But if your estate passes to a child, then IHT at 40% will normally have to be paid on anything over the £325,000 nil-rate band (NRB).

This means couples often leave everything to each other. However, you could make provisions to ensure that your nil-rate band legacy is left to your children, via a trust for example, with the rest of your estate going to your spouse or civil partner. This could ensure assets are passed to children and other loved ones without attracting IHT.

If you own residential property and leave the property to your nearest decedents, such as children, grandchildren and great-grandchildren, you will additionally benefit from the ‘residence Nil Rate Band ’ in addition to the £325,000 NRB. The Residence Nil Rate Band is £175,000 in the 2020/21 tax year.

Additionally, registered charities are exempt from Inheritance tax and therefore will benefit from 100% of your gift. If 10% or more of your net estate is left to charity, the positive effect of this is that the remaining taxable estate is taxed at 36% rather than the usual 40%.

The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief generally depends on individual circumstances.

* Will writing involves the referral to a service that is separate and distinct to those offered by St. James's Place. Wills and Trusts are not regulated by the Financial Conduct Authority.

** If you make a pension contribution while you are in serious ill health and don't survive to take your retirement benefits, there may be a tax charge to pay, as you may be deemed to have deliberately tried to avoid IHT. To reduce the possibility of a disagreement with HMRC, it is sensible to seek professional financial advice.