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Inheritance Tax Planning

Who pays Inheritance Tax (IHT) and how is it calculated?

Every person in the UK receives an allowance – known as a nil band rating – of £325,000 which is the value of assets a person can pass to their beneficiaries after death before it becomes taxable at a rate of 40%.

If the estate of the deceased includes the family home, then an additional allowance – known as a Residential Nil Band Rating – of £175,000 is available taking the individual allowance to £500,000. The allowances can also be passed from spouse to spouse, so a married couple can have a potential Inheritance Tax Free Allowance of £1 million and anything above would be subject to 40% tax.

When deciding if an estate is taxable, HMRC consider property, savings, investments, and other possessions. However, from April 2027 pensions will also be included in the calculation which will see many people currently under the allowance now having an IHT liability and others who previously had IHT liabilities, now with a larger tax bill to settle.

Generational Inheritance Tax

Generational IHT has become an increasing issue over the years as property values have risen, wages increased and many contributing more to SIPPs pensions and other investments. Serious consideration needs to be given to beneficiaries of the Will. Consider, children will be working creating their own wealth, paying into company and private pensions and the same applying to their spouse, if their combined assets reach £1M for a married couple every £100,000 you pass could create a £40,000 Tax loss.

Many people do not realise that although they do not have IHT to pay they may be starting a chain of events that lead to their children having to settle IHT on their estate or, in many more cases nowadays, the estate being taxed multiple times on the same assets over a period of generations. Generational IHT is unnecessary and with the correct IHT planning can be completely avoided.

Example 1:

Mr & Mrs Smith have assets, including the family home, totalling £800,000 which they leave it to their son, Paul. The Smiths do not pay IHT on their death as their tax-free allowance would be £1 million. However, when their son passes, he has brought his own property, saved, invested and contributed to pensions.

The estate Paul has accrued is also valued at £800,000. Even if Paul receives the full tax-free allowance of £1million, his estate plus the inheritance from his parents now takes him over the allowance by £600,000. This would generate an Inheritance Tax bill on Paul’s death of £240,000 even though neither Paul nor his parents breeched the IHT thresholds on their own estates.

Example 2:

Mr & Mrs Jones have a total estate value of £1.5 million, so on the last passing they are taxed 40% on the £500,000 over their nil band ratings. The tax bill would be £200,000.

This leaves an inheritance of £1.3 million, and if, as is the norm, the inheritance is passed to their children then it is highly likely that with the children’s assets added to the inheritance they receive, more inheritance tax liability will have been generated.

What can be done to plan for Inheritance Tax?

There are many ways in which inheritance tax can be reduced, one of the most common ways is to “gift” assets or monies to the beneficiaries while you are still alive. Done correctly, this can significantly reduce or even eliminate the inheritance tax payable on an estate.

However, there are stipulations on how this can be done for the gift to qualify as a Potentially Exempt Transfer (PET) and it is important to obtain professional advice not only so the criteria for a PET are met, but also to ensure that the transfer does not have other implications, such as Capital Gains Tax, Income Tax or deemed as a deliberate attempt at Deprivation of Assets.

When “Gifting” assets timing is also a significant factor. The inheritance rate of 40% tapers off over a period of 7 years, so we are always better starting our inheritance tax planning sooner rather than later. If somebody passes within the 7 years, the tapering to the tax rate will still apply but the full benefit not achieved.

Charitable donations can also be a way of reducing the taxable size of an estate and receiving a reduction in the 40% basic rate.

The absence of a will means your assets will be distributed in accordance with the laws of Intestacy. These may not reflect your own personal wishes or circumstance and could see your assets in the wrong hands or family members becoming disinherited.

Losing a loved one is difficult for any family and without a correctly prepared Will the family may find themselves with complex legal processes in order to complete your affairs and this will take considerably longer and incur expensive legal fees.

Its important Wills are reviewed regularly to ensure they reflect your wishes and remain valid. Often families’ circumstances can change, such as the birth of a grandchild or the passing of a beneficiary therefore its important the Will is kept up to date.

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