Keeping wealth within the family is desirable but not always easy to plan. There is a myriad of Inheritance Tax (IHT) rules to mitigate and these are often complicated and subject to change. As Financial Planners, we are here to help clients navigate this complex landscape and leave a meaningful legacy for their loved ones, without paying unnecessary tax.
In this short guide, our financial planning team will be sharing some ideas on how clients with complex estates can leave their wealth to younger generations.
The Nil-Rate Band
The Inheritance Tax (IHT) threshold, also known as the nil-rate band (NRB) refers to the threshold after which you start paying IHT (usually 40%) on the value of your estate. In the 2019-20 tax year, this is set at £325,000 and includes the value of your home. So, if your estate is worth £500,000 when you die, then £175,000 is potentially liable to be taxed at 40%.
However, there are a number of IHT rules which can affect your threshold, and how much you pay. First of all, married couples and civil partnerships can inherit any unused IHT allowance from their deceased spouse. If they have not previously used any of this allowance, then the surviving spouse can effectively “double” their IHT threshold to £650,000.
Secondly, there is also an important caveat regarding your home. If you pass on your family home to direct descendants (e.g. children or grandchildren) when you die, then you can raise your IHT-free threshold using an additional nil-rate band (ANRB). In 2019-20, this allows each individual to pass on an extra £150,000, tax-free.
Again, married couples and civil partners can combine their ANRBs to potentially shield £300,000 of property value from the tax man. It’s also worth noting that this threshold will be raised to £175,000 in April 2020, which could allow couples to pass a £1m estate to their direct descendants completely free of IHT. For many people living in the South East this is welcome news in light of rising property prices, which might have tipped their estate over the IHT bar.
It may sound strange to focus on pensions in an article about estate planning, but they can be a vital tax-saving tool. Under current rules, your pension is excluded from the value of your estate for IHT purposes, allowing you to potentially pass hundreds of thousands of pounds to your loved ones without these funds being potentially liable to IHT.
However, you do need to be careful with this and we recommend speaking to one of our experienced financial planners to ensure your pension is properly integrated into your estate plan. For instance, final salary pensions rarely (if ever) can be inherited by children, although there are often reduced benefits for a surviving spouse. Your state pension, moreover, cannot be passed down to your children or to your husband, wife or partner.
It is those with defined contribution pensions who can primarily make use of this part of the IHT system. Even then, however, there can be tax implications. If you die before the age of 75, for example, then under current rules your beneficiaries can receive any pension funds tax-free. If you die after this age, however, then it might affect their Income Tax bill (possibly pushing them into a higher tax bracket).
There are a range of other IHT-mitigation tactics open to people with complex estates, depending on your personal circumstances:
- For those interested in small businesses or startup investing, the Enterprise Investment Scheme (EIS) may be worthwhile considering. Here, you can invest up to £1m per tax year into EIS-qualifying companies and receive up to 30% tax relief against your Income Tax bill. Provided you hold your EIS shares for at least two years, these can also be passed down to beneficiaries, IHT-free.
- Trusts can be a great way to reduce IHT whilst retaining a degree of control over your assets. Not only can this help to protect your child’s legacy if your surviving partner decides to later remarry, a Trust can help you control how the money is spent on you children and grandchildren. However, make sure you seek independent financial advice before committing to a Trust, as these come in different forms with a variety of rules.
- Life insurance is also an option to consider, as the payout from your policy can be used to cover a potential future IHT bill. Bear in mind that you need careful financial planning if you are considering this, as the insurance policy itself can be included in the valuation of your estate (e.g. if it is not properly written into a Trust). You also should speak to us to ensure whether an insurance policy makes financial sense for you. In some cases, it might be cheaper to simply pay the future IHT bill than pay for the policy.
Do give us a call if you wish to discuss this area of advice in more detail!