Insights

Currently one of the fastest growing sources of revenue for the Treasury is inheritance tax which generated £7.1bn in the 2022-23 financial year. This is a £1 billion increase on the year before, which appears to reflect the frozen nil rate allowance together with rising house prices and inflation.

This has the same fiscal drag effect for taxpayers as freezing income tax thresholds. More estates are now facing IHT in the same way that more income is now within the higher rate income tax brackets for most people. Current policy is that the IHT threshold will not be reviewed until at least 2025-26.

According to the Financial Times, the effects of “fiscal drag” mean that HMRC increased its total tax take by 9.9 per cent in 2022-23. This is double the rate of increase in 2009-10 and the IHT payable is higher, with receipts having trebled in the same period.

Options to manage inheritance tax

If you are concerned about the impact of IHT, the sooner you start planning the better. There are various simple options to consider as we outline below:

Make a will
Sounds obvious, but far fewer people are making wills than you would expect – 60% of people don’t have one – and yet it ensures your assets will be distributed according to your wishes. Each individual is able to pass on £325,000 tax free each; for married couples and civil partners this is £650,000 in total. Depending on the size of the estate, a further £175,000 each can be passed on tax free to descendants in the form of the family home. The result is that total reliefs of £1m are available to a couple. .

Make a habit of giving away small amounts
Anyone can make gifts of up to £3,000 each tax year and these will fall outside their estate immediately. This gift allowance of £3,000 can be carried forward for one tax year if unused.
Annual gifts of up to £250 per annum to any one person will also fall outside the estate immediately. Additional gifts can be made for special occasions – marriages for example – at a rate of £5,000 to a child or £2,500 to a grandchild.

Make gifts out of income
If you have surplus income, consider making regular gifts out of that income. This is often overlooked and can result in a substantial reduction in an estate over a period of time. Gifts out of surplus income fall outside the estate immediately; it is however important to keep detailed records of income and expenditure to demonstrate the excess, and to ensure the gifts made are regular (e.g. monthly) payments.

Make lifetime gifts
Large one-off gifts to other individuals, termed potentially exempt transfers (PETs), do not attract an immediate inheritance tax charge. Provided the donor survives 7 years after the date of the gift it falls entirely outside their estate. Consider making large gifts every 7 years to use the £325,000 lifetime exemption repeatedly. On death within 7 years of a gift, the value of that gift falls back within the donor’s estate and to the extent that it exceeds £325,000 it will attract inheritance tax which is the liability of the donee. Tapering relief attaches to this liability for gifts made between 3 and 7 years before death.

Place assets on trust
A trust can be a useful inheritance tax planning tool if you wish to maintain some element of control over how the assets are accessed in the future, for example a discretionary trust can be used to benefit a group of beneficiaries such as grandchildren. Income within the trust is subject to additional rates of tax (45% currently) but the trust beneficiaries are able to receive income with a refundable tax credit against their own tax liabilities.

An alternative to the discretionary trust is an interest in possession (IIP) trust. This is useful when the beneficiary needs to be able to use the asset or have an entitlement to ongoing income from it, for example a requirement within a will that guarantees a spouse has the right to live in the donor’s share of a property for life, after which it reverts to the children. Any income is effectively taxed at the beneficiary’s rate of income tax and when the beneficiary dies, the trust is automatically dissolved.

Transfers onto trust are restricted in use because such gifts are chargeable lifetime transfers (rather than PETs) and they attract inheritance tax at the lifetime rate of 20% to the extent they exceed the available lifetime exemption of £325,000. Any capital gains arising on the transfer of property onto trust can however attract holdover relief for capital gains tax purposes.

Maximise business assets
Qualifying business assets such as shares in your own trading company, AIM listed shares, and EIS or SEIS approved business investments can attract business property relief which reduces the inheritance tax liability. Such assets require only a 2 year holding period before the relief can apply at the rate of either 50% or 100%, depending on the asset and the holding.

Inheritance tax planning is complex and whilst the above actions are simple in nature, there are many pros and cons to consider. The most savings can be achieved by planning well ahead and making gifts over a long period of time. To review your inheritance tax profile and consider the best approaches, contact us via partners@rjp.co.uk.

RJP LLP is also licensed by the Institute of Chartered Accountants in England and Wales to carry out the reserved legal activity of non-contentious probate in England and Wales. Email us to learn more about our probate services via partners@rjp.co.uk.