Estate planning is all about ensuring that the right people get the right financial assets and/or financial assistance at the right time. Losing family wealth to inheritance tax or hostile creditors can have a significant negative impact on your wider wealth-planning objectives.
It is common for married couples and civil partners to put off comprehensive estate planning until the death of the first partner. This simply defers the problem to a time when making important financial decisions may be more difficult.
The current inheritance tax (IHT) regime is relatively benign, with many legitimate and well‑established planning opportunities available to those who wish to reduce or avoid an IHT bill. However, with government finances under severe strain, it is unlikely the IHT regime will avoid change. Since dead people cannot vote, the temptation for future governments to tinker with the existing legislation is likely to be hard to resist.
Currently, IHT at a rate of 40 per cent is applied on the death of UK domiciled and – potentially – non-UK-domiciled individuals on most types of wealth above a certain level.
Key exemptions
A number of exemptions and allowances can be utilised to reduce the value of your estate and therefore the amount of IHT due. The main ones are laid out below.
• There is an exempt estate amount (often referred to as the ‘nil‑rate band’), which is £325,000 per person.
• Property owners are entitled to an extra £175,000 exemption on a sliding timescale (although full implementation of this exemption has been deferred until April 2020).
• For non-UK-domiciled individuals, IHT only applies to their UK assets. The tax rate is currently 40 per cent on all non-exempt assets above £325,000, including chargeable gifts made within the last seven years. The tax treatment of non-UK domiciles is currently under review, with the period of UK residence after which an individual is deemed to be UK-domiciled for IHT purposes set to reduce from 17 to 15 years from April 2017.
• Transfers of any amount between UK-domiciled spouses and civil partners, whether in lifetime or on death, are exempt from IHT (they are limited to £325,000 when the recipient is non-UK-domiciled).
• A non-UK-domiciled spouse or civil partner with a UK-domiciled spouse or civil partner (or their legal personal representatives within two years of their death) may make an irrevocable election to be treated as UK-domiciled for IHT purposes only. This will then apply to the previous seven years. The election will cease to apply if the individual ceases to be tax resident in the UK for at least four successive tax years after the election.
• Married couples and civil partners may carry forward their deceased spouse or civil partner’s unused nil-rate band, with the amount of the nil-rate band determined by the exemption applicable at the time of the second partner’s death.
• An annual gift of £3,000 is immediately exempt, as is £3,000 from the previous tax year, if it was not used.
• An annual gift allowance of £250 to any number of individuals is immediately exempt, provided that the recipient does not also receive part of the £3,000 annual gift exemption.
• Regular gifts that meet the definition of being from ‘surplus income’ are immediately exempt.
• Certain qualifying assets benefit from business or agricultural property relief (BPR or APR) and are exempt at the rate of 50 per cent or 100 per cent, depending on the circumstances.
• Gifts in consideration of marriage are immediately exempt: parents may gift up to £5,000, grandparents £2,500 and anyone else £1,000;
• Loans are deductible from the deceased’s estate for IHT calculation purposes, provided they are repaid on death and have not been used to acquire, enhance or maintain certain types of property.
• Gifts made to charities registered in the UK or the EU, or to qualifying political parties, in lifetime or via a will, are immediately exempt from IHT.
• Any lump sum death benefits paid from a registered pension scheme set up under an appropriate trust will be exempt from IHT, as long as they are paid out to the beneficiaries within two years of the member’s death and the plan contributions (or any transfers in from previous pension schemes) were not made while the member was in serious ill health (that is, when their life expectancy was shorter than two years).
• A life insurance policy that is assigned to a suitable trust before it acquires a surrender value and where the premiums are either within the annual gift exemption (£3,000) or payable from normal ‘surplus income’ should not form part of the donor’s estate for IHT.
• Gifts of most types of assets to individuals or to the trustees of bare trusts are known as potentially exempt transfers (PETs) and are exempt if the donor survives for seven complete years.
• If the donor does not survive a PET by seven years, the gift will become subject to IHT. Any tax due will be eligible for a reduction (known as taper relief), on a sliding scale from 8 per cent to 32 per cent, if death occurs after the first three years.
• Gifts to most types of trusts are taxable at the rate of 20 per cent at the time they are made, unless they are within the available IHT nil-rate band (when aggregated with any previous gifts to trusts made within the previous seven years), in which case there is no immediate tax charge.
• If the donor survives a gift made to most types of trusts (whether or not tax was payable at the time the gift was made) by seven full years, IHT is restricted to a periodic charge every 10 years equal to a maximum of 6 per cent of the value of the trust above the then-applicable nil‑rate band.
Thanks largely to the boom in the UK property market, far more people are discovering that their estates may face an IHT bill on their death. That said, the ability for an unused nil-rate band to be passed to the surviving partner on first death, the introduction of the extra nil-rate band covering property and the many exemptions and allowances available mean that, in most cases, and with a bit of judicious planning, any potential IHT liability can be significantly reduced.
Carolyn Gowen is a chartered wealth manager at Bloomsbury Wealth, a trading name of Raymond James
Key points
• A number of exemptions and allowances can be utilised to reduce the value of your estate and therefore the amount of IHT due.
• The exempt estate amount (often referred to as the ‘nil-rate band’) is £325,000 per person.
• Gifts of most types of assets to individuals or to the trustees of bare trusts are known as potentially exempt transfers (PETs).
