Inheritance Tax & Estate Planning: Engage Guide To Wealth Management
Part 1: Inheritance Tax (IHT) Planning
How financial planning can mitigate or reduce IHT.
Inheritance Tax is a tax on the estate (property, money, and possessions) of someone who has died. The standard rate of IHT is 40%, but it is only charged on the part of your estate that exceeds the IHT threshold. Pensions will be included in the estate for IHT purposes from 6 April 2027. It is calculated on the ‘net’ value of the estate after debt and liabilities have been accounted for.
The Nil Rate Band (NRB)
The Nil Rate Band (NRB) is the threshold up to which an estate can be passed on without IHT. As of the current tax year, the NRB is set at £325,000 per individual.
This means that if the total value of your estate is below £325,000, no IHT will be payable. However, any amount over this threshold will be subject to the standard 40% IHT rate.
It a spouse or civil partner dies and doesn’t use part or all their NRB, the unused NRB may be transferred to the surviving spouse or civil partner and added to their own NRB and used on their death. This could therefore increase the threshold for IHT to £650,000 on the estate of the surviving spouse or civil partner.
The Residence Nil Rate Band (RNRB)
The Residence Nil Rate Band (RNRB) is an additional allowance that applies if you pass your main residence to direct descendants (children or grandchildren). The RNRB is currently £175,000.
Similarly to the NRB, the unused RNRB can be transferred to a surviving spouse or civil partner.
When combined with the standard NRB, this provides a maximum allowance of £500,000 for individuals, or £1 million for married couples or civil partners.
Example: a property valued at £1m could be passed to children or grandchildren, on second death without paying inheritance tax, if this was the only asset in the estate.
Example: if a couple’s estate was worth £1.2 million (and the main residence was worth more than £325,000), the estate would pay 40% IHT on £0.2m, which is £80,000. Their effective rate of IHT is therefore 6.7%.
Lifetime Gifts and the Seven-Year Rule
Gifting assets during your lifetime can be an effective way to reduce your estate's value and, consequently, your IHT liability. However, such gifts are subject to the seven-year rule. If you survive for seven years after making a gift, it will be exempt from IHT. If you pass away within this period, the gift may still be subject to IHT, although the rate may be reduced depending on how long you survived after making the gift.
To Gift or Not to Gift
A key aspect of IHT planning is retaining access to assets that might be needed in your lifetime verses the inheritance tax consequences of having excessive assets tax to IHT. One of the greatest fears then IHT planning is giving away too much and not having enough. With sensible planning and having the right IHT structure in place, this can be managed.
Planning for Liquidity
Ensuring that your estate has sufficient liquidity to cover any IHT due is another key aspect of IHT planning. Without proper planning, your heirs may be forced to sell assets, such as property, to pay the tax bill. Strategies like life insurance or setting aside specific funds can help ensure that your estate has enough liquidity to meet its obligations.
Debt Management
Debt, including mortgages, are deducted from the estate value. Using debt, such as a Lifetime Mortgage, can help turn an illiquid asset into a liquid one, providing capital to gift and give away or facilitate other planning.
“ Like all planning, there is no single solution for everyone, and careful consideration should be paid to the costs versus the potential benefits...
Knowing what allowances are available to you can help with maximising your opportunities for IHT mitigation.
Annual Exemption
Every individual has an annual gift allowance of £3,000, which can be given away without attracting IHT. If you didn’t use your allowance last year, you can carry it forward, allowing you to gift up to £6,000 tax-free in a single year.
Small Gifts Exemption
You can give as many gifts of up to £250 per person as you like each tax year, provided the recipient hasn’t received any part of your annual exemption.
Gifts on Marriage or Civil Partnership
You can give tax-free gifts to someone getting married or entering a civil partnership. The amount you can give depends on your relationship to the recipient:
Parents can give up to £5,000
Grandparents can give up to £2,500
Anyone else can give up to £1,000
Normal Expenditure Out of Income
If you make regular gifts out of your income, rather than your capital, these gifts can be exempt from IHT, if they don’t reduce your standard of living. This is particularly useful for those with surplus income who wish to reduce the value of their estate gradually.
Business Property Relief (BPR)
If you own a business, shares in an unlisted company, or agricultural property, you may be eligible for Business Property Relief (BPR). BPR allows these assets to be passed on free of IHT, or with a reduced tax rate, depending on the nature of the asset and the period it has been owned.
Charitable Donations
If you leave at least 10% of your net estate to charity, the IHT rate on the rest of your estate can be reduced from 40% to 36%. Charitable donations are fully exempt from IHT and can be an effective way to reduce the overall tax liability of your estate.