In 2007 George Osborne announced his intention to increase the nil rate band, the amount you can leave in your estate without paying Inheritance Tax, to £1 million. Fast forward six years and the government has announced that to help meet the cost of changes to how long term care is paid for, the nil rate band will be frozen at £325,000 until 2019 at the earliest.
If the nil rate band had been increased to £1 million, most estates in the UK would have paid no Inheritance Tax whatsoever, however with the rate now frozen, and not even increasing with inflation, more people than ever will be dragged into the Inheritance Tax net.
Given this news, we thought now would be an ideal time to suggest six ways of avoiding, or at least reducing, the impact of Inheritance Tax.
1. Make a will*
This is the most basic form of estate planning, but many of us don’t get round to making a will, which means on our death the state decides how our assets are distributed.
Not only does making a will allow you to decide who gets what when you die, it also means you can arrange your affairs in a more tax efficient way.
If you take nothing else from reading this article then arrange to see a solicitor and make sure you have an up to date will in place, the cost if probably far less than you think.
2. Use the exemptions
There are certain exemptions, stipulated, by HM Revenue & Customs (HMRC), which we can all take advantage of.
Whilst the exemptions generally involve giving assets away, they are useful and should be considered as part of any Inheritance Tax mitigation strategy.
Using an exemption means that assets will immediately fall outside your estate, there is no need to survive for seven years as is the case with other gifts. The most important exemptions include:
- The annual exemption allows you to give £3,000 of assets away each year
- The small gift exemption allows you to make gifts of up to £250 to any number of individuals, providing they have not received any assets from you under the annual exemption
- In respect of weddings and civil partnerships parents can give gifts or cash of up to £5,000, grandparents up to £2,500 and anyone else up to £1,000
- The final key exemption relates to gifts from spare income. Whilst this is a little more complex than the other exemptions, in a nutshell, it allows surplus income, which you can prove you don’t need, to be gifted away
Clearly the exemptions involve gifting assets away, which is not an option everyone is comfortable with, but if you have surplus assets or income then you should taking advantage of these rules.
3. Put life insurance into trust
Many people have some form of life cover, especially those people with children, which will provide a lump sum of money, on their death.
Life cover can come in many forms but the two most common are Level Term Assurance, which is a taken out personally, and death in service, which arranged through your employer.
Unless the life cover it written in trust, the lump sum will be paid into your estate, which could then be subject to Inheritance Tax, depending of course on the size of your estate and the amount of money paid out.
Writing the life cover in trust, which is simple to do, will help avoid this problem whilst still making the lump sum available to your financial dependents.
4. Consider investments which qualify for Business Property Relief
Certain assets, for example, but not limited to, unlisted shares and shares quoted on AIM (Alternative Investment Market) qualify for Business property Relief or BPR for short.
Providing you have held the qualifying asset for over two years it will be exempt from Inheritance Tax when you die.
The BPR rules were originally designed to allow family businesses to be passed on to future generations without Inheritance Tax being paid, however they can also be used in other circumstances. For example, it is possible for individuals to invest in assets which qualify for BPR, once these assets have been held for two years they will be exempt from Inheritance Tax.
The key advantage of this solution is that the individual can keep control of their assets, without the need to gift them away, or tie up capital in complex trust arrangements which can’t be unwound.
As the investments within a BPR type arrangement are often different to those you may have used before, anyone considering this type of solution to their Inheritance Tax problem should make sure they are happy with how their money will be invested, as well as focusing on the Inheritance Tax benefits.
Although pensions are primarily designed to provide an income in retirement they also have benefits from an Inheritance Tax perspective.
If you die before retiring, or more specifically prior to taking benefits from a money purchase pension, for example a Personal Pension or SIPP (Self-Invested Personal Pension) then the value is paid out to your beneficiaries in full and isn’t subject to Inheritance Tax.
The rules are different for defined benefit and final salary pensions; however they are still tax efficient.
6. Insure the problem
If you dislike the idea of giving assets away or changing your investment strategy to take advantage of Business Property Relief, then one very simple way of addressing issue is simply to insure the problem.
Whilst this route means Inheritance Tax is still paid, it benefits from being simple and is certainly non contentious, as HMRC are still receiving the tax due.
For couples who want to pass their entire estate to each other on the death of the first person and then onwards to other beneficiaries, possibly children, when the second person dies this option is very simple. A joint life Whole of Life (WOL) insurance policy is taken out, with a sum assured sufficient to pay the Inheritance Tax due, payable on the second death of the couple.
On the death of the surviving spouse the sum assured is paid out and used to pay the Inheritance Tax due, leaving the estate intact for the beneficiaries.
Although the premiums on the WOL policy need to be paid, these can be surprisingly affordable and income could be taken from other investments to help meet the cost.
Despite the cost, this option has significant advantages, particularly for those people who do not want to give assets away, change how they invest or who require a simple solution to their Inheritance Tax problem.
Inheritance Tax used to be referred to as a voluntary tax, with changes to legislation that is certainly no longer the case, however with pretty basic planning and thought it can be avoided, allowing you to leave a larger estate to your loved ones.
*The FSA does not regulate will writing, or trust and taxation advice.