Inheritance tax (IHT) is a complex tax to which we are all assessed. The amounts involved can be very large, making it important to take time to plan your estate effectively. This is particularly pertinent to those in retirement, of course, but also affects much younger people with assets such as investments, cash and property which might pass down to children or other dependents. In this article, our financial planning team at Vesta Wealth offers some thoughts on how to mitigate an IHT bill in the 2021-22 tax year.
Navigate the IHT threshold
The rate of IHT on death is 40%, which is applied on the value of your estate (e.g. cash, property, possessions and investments) over £325,000. If everything falls under this limit your estate should not have to pay IHT when you die. However, this may not always be the case. Inheriting a future lump sum, for instance, could push you over the threshold, as could other things which increase your wealth.
Here, it is important to consider tax-efficient ways to grow your wealth. Pensions tend to be tax efficient and under current rules you can normally pass down any unused defined contribution pension funds to your beneficiaries, free from IHT. This makes pensions not only a tremendously useful tool for retirement planning but also possibly for estate planning.
For instance, one strategy might be to draw more funds from your ISA(s) for your retirement income rather than your pension. This is because pensions are exempt from IHT, but ISAs are not.
Another idea is to consider IHT-free investment opportunities. For instance, if you buy shares in companies which qualify for the Enterprise Investment Scheme or Seed Enterprise Investment Scheme (EIS & SEIS), then these are exempt from IHT if held for at least two years.
IHT and life insurance
One idea to mitigate an IHT liability is to take out a life insurance policy which pays out a big enough lump sum to cover the bill when you die. This can work, but without careful planning the lump sum will then form part of your estate, making it also subject to IHT!
This is where a trust can help. By writing the policy into a trust structure, the insurance company can pay beneficiaries the lump sum upon the settlor’s death, tax-free. However, it is important to seek professional advice before rushing to take out a policy. This is because you must be sure that you can keep up paying the premiums across the full duration of the policy. Depending on the type of plan, these may rise as you age and as your lifestyle changes. In the worst-case scenario, someone may take out a policy which simply becomes unaffordable in old age. In many cases, it may be better simply to pay the IHT bill or explore other mitigation strategies.
Making gifts
Eventually, your wealth will pass to your beneficiaries. This could happen all at once (i.e. when you die and the estate is distributed), or you could gradually pass down pieces of it throughout your lifetime. The reason to consider doing the latter is that each individual is entitled to an annual exemption which lets you give away up to £3,000 to one person or split between many people, free from IHT.
Whilst you cannot easily give away pieces of your main home, you could send cash gifts each year to your beneficiaries or, pass down possessions which have a value. Over many years this could result in a significant saving. For instance, if you gifted a total of £30,000 over 10 years then this could save £12,000 in IHT i.e. £30,000 x 40%.
You can also give away as many individual small £250 gifts as you like, free from IHT. For a child’s wedding, you may also give them an IHT-free gift worth up to £5,000. For a grandchild’s wedding the maximum amount is £2,500, and for anyone else it is £1,000.
In some cases, it is also possible to make gifts out of normal expenditure, of any amount, without them being part of your estate on death.
Passing down your home
In addition to having a nil rate band of £325,000, there may be an additional allowance if you qualify for the Main Residence Nil Rate Band (MNRB). Here, you can pass down an extra £175,000, IHT-free, provided this includes your main home and the beneficiaries are direct descendants e.g. children or grandchildren.
Another useful aspect of the rules here is that married couples and civil partners can combine their IHT thresholds and MNRBs. Since each person is entitled to £325,000 and £175,000 when passing down their main home to direct descendants, this could, theoretically, combine to a total of £1m that could be passed down IHT-free.
Invitation
If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.