Insights

No one likes paying tax, but inheritance tax (IHT) is perhaps the most disliked tax of all, because it comes at a highly emotional time and the assets involved have often been accumulated, out of taxed income, over many years of hard work.

Recent statistics released by HMRC suggest that IHT is not just an ‘optional tax on the very rich’, and that many ordinary ‘asset rich but cash poor’ people are affected. This is verified by the number of estates on which inheritance tax is payable, which are published by the OBR (Office for Budget Responsibility).

In the 2015/16 tax year, 40,100 estates were subject to inheritance tax and of these, 26,000 estates paid out a total of £4.7bn of IHT. Just 6,500 of these estates were what HMRC classifies as those of high net worth individuals; with assets in excess of £20m.

It is expected that for the 2016/17 tax year, the number of estates caught by IHT will have risen to 45,100, which equates to 8% of all estates in the UK. By 2020/21, revenues from IHT are expected to increase to £5.6bn.

To mitigate the impact of inheritance tax on your estate, it is important to be thinking ahead. Lifetime giving remains the most popular strategy, but requires that you have sufficient funds to give away, being sure that you won’t need them in the future. As gifts over the annual exemption only fall completely outside your estate after 7 years, it also requires that you think significantly ahead.

This article helps explain some of the other options to consider.

Use the new RNRB to pass on the family home

With effect from April 2017, inheritance tax thresholds have been extended in certain circumstances for estates owning a personal residence. The residence must have been occupied as a residence at some time but does not need to have been a main residence; it is possible to elect which property obtains the relief and there are provisions to ensure that someone who downsizes in later life is not disadvantaged.

With effect from 5 April 2017, an additional allowance of £100,000, known as the residence nil rate band (RNRB) can be claimed on top of the existing £325,000 inheritance tax exemption. This amount will increase to £125,000 in 2018, £150,000 in 2019 and £175,000 in 2020. Therefore from 2020, married couples and civil partners will effectively have a £1m exemption between them, being the lifetime exemption of £325,000 each, plus the RNRB of £175,000 each.

This extension to the threshold is transferable between spouses but is only available in situations where an estate is to be directly inherited by a family member i.e. children, step children or grandchildren of a deceased, or their spouses. Other relatives such as brothers, sisters and nieces and nephews are excluded. The relief is also withdrawn by £1 for every £2 by which an estate exceeds £2m, which means that it is lost once an estate exceeds £2.35m (or £2.7m for a surviving spouse).

It is important to note that the relief only applies to transfers of qualifying residential property on death to qualifying descendants, so property gifted before death cannot qualify.

Prior to the introduction of the transferrable nil rate band and now the RNRB, it was common, as part an of inheritance tax planning strategy, for wills of married couples to provide that on the first death, property would be placed on trust for the ultimate beneficiaries, providing for the lifetime use of the remaining spouse. This ensured the lifetime exemption was utilised on the first death. This is no longer necessary and can now have detrimental effects, especially following the introduction of the RNRB. Therefore, any existing wills which may include this type of planning should be reviewed.

Using trusts which retain some access to capital

Lifetime giving is a very effective inheritance tax planning strategy, but it is only effective where a taxpayer has enough assets to be able to afford to give assets away, and where the process has begun early enough. It is also necessary to consider the capital gains tax position where assets gifted are other than cash.

What happens however if you suddenly need to access the money for care costs or other unexpected expenses? If you have given your assets away for tax purposes, you cannot then reclaim them.

In situations where the assets may be required in the future and time is of the essence, investment options may be worth considering. These require expert financial advice from an advisor who is regulated to provide financial advice. However, a brief outline of how they might work is as follows:

• Discounted gift trusts

These are UK trusts set up to make an investment in either an onshore or offshore investment bond. They enable you to gift a lump sum into a trust, which leaves your estate fully once you have survived for 7 years after the gift, but they also enable you to retain a lifelong ‘income’ from that money (which is technically withdrawals of capital).

• Loan trusts

These trusts enable you to make an interest free loan repayable on demand, the proceeds of which are placed in a single premium life insurance bond written in trust for your chosen beneficiaries. As the bond grows in value (assuming that it does) the growth will immediately fall outside your estate for the benefit of your beneficiaries. Whilst there is no requirement to survive for a period of time, the value of the gift remains in your estate.

• Wealth preservation trusts

These trusts are used to provide for a spouse and future generations and to attempt to protect assets against possible third-party claims. They split the beneficial enjoyment of the assets from their legal ownership, which rests in the hands of the trustees. They also potentially eliminate the requirement to obtain probate.

Passing on business assets 

Business Property Relief (BPR) is a special form of inheritance tax relief, which is available for taxpayers who own qualifying business assets. It can mean a reduction of between 50% and 100% in the amount of IHT payable.

In order to qualify for the relief, the qualifying investment must have been held for two years at the time of death.

Whilst many individuals already own qualifying assets, such as shares in their own company, those who do not, and who wish to obtain protection for their estate within a shorter time frame than 7 years, may wish to consider the benefits of acquiring assets that will benefit from the relief. In certain circumstances BPR applies to shares held in AIM listed companies and to investments held in companies that fall within the Enterprise Investment Scheme (EIS).

EIS investments of course offer other tax advantages, for example income tax relief on the amount invested, capital gains free growth and the ability to delay the payment of capital gains tax on other gains.

Inheritance tax is clearly very complex and this article covers only a small area. For a full review of your situation and consideration of the different IHT planning options available, please contact Lesley Stalker by emailing partners@rjp.co.uk for more information.