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Is Inheritance Tax avoidable?

6 min read
David Little, Senior Financial Planning Director08 Nov 2023

“By failing to prepare, you are preparing to fail” This famous quote by Benjamin Franklin perfectly describes the impact of ignoring the effect of Inheritance Tax on your family wealth.

Passing down our hard-earned estate to our loved ones is normally an objective for most people. As part of Talk Money Week 2023 (6-10 November), we have compiled some key considerations to assist with meeting this goal and lowering the impact of “death taxes”.

Inheritance Tax: too late to go back?

Gordon Brown, the previous Chancellor of the Exchequer, famously stated that Inheritance Tax (IHT) is “a voluntary tax”, sparking a lengthy and somewhat spirited debate on this topic.

In simple terms, IHT is charged to the deceased’s estate when it is valued above their available tax-free allowances. Currently the allowances are £325,000 as a nil rate band, with a potential further £175,000 as a residential nil rate band. If the deceased was married or in a civil partnership, inter-spouse transfers are exempt from IHT so typically IHT is charged on the second death of the couple. Furthermore, both tax-free allowances can be used on second death if available taking the potential allowances to £1m.

There is a reason why IHT is viewed by many as the tax on the wealthy, but that notion has rapidly changed in recent years. Amid stagnant tax-free allowance thresholds and the rising value of residential property, more and more families are finding their hard-earned family wealth reduced by the highly punitive 40% tax on death.

So, are there ways to mitigate this tax? Absolutely! Will this completely remove IHT from the estate? Probably not… but it is highly likely the liability can be significantly reduced if you plan.

Professional financial planning is the key driver to avoiding, or at least reducing, an IHT liability. Like all good plans, the earlier you start the planning conversation, the more favourable the outcome could be. Think of IHT as a “ticking timebomb”: the sooner you tackle the countdown, the better the result.

The first step in the journey is to understand the value of your estate. This entails gathering a list of all assets along with how they are held in your estate. As soon as you have established this, it becomes a more straightforward calculation using the available allowances, along with any prior gifts that have been made.

Once you have established the potential liability, a professional cashflow model can help immensely in building a structure. This will allow you to understand what areas of your wealth are genuinely surplus to requirements, to then allow a sensible plan to be constructed to pass wealth outside of your estate.

The main function of a cashflow model, along with assisting with IHT planning, is to understand your requirements for inflation-linked income and expenditure in retirement, including any one-off purchases planned or “bucket list adventures”.

It also helps establish if your different assets are used collaboratively for a very tax-efficient income stream, instead of opening your pensions which is the traditional method of obtaining retirement income. Further uses include forecasting potential care home costs, the effect of downsizing your home, any charity donations you might have in mind, or if you should consider passing control of your wider assets into a Trust.

Options are never a bad thing

While it may feel a bit overwhelming to think about all these estate-related matters, taking no action is rarely, if ever, the right option. The first step can seem daunting, but this first step is often converted into significant tax savings and the preservation of wealth for your loved ones.

To make the process less burdensome, we’ve put together some tips to help you prepare your financial future:

  1. Once you have a clear idea of where you hold your wealth and of your wishes when you pass away, communicate them to your family and your loved ones. Having a conversation is by far the best first step.
  2. If the maturity or financial awareness of your beneficiaries is a worry, consider using a trust to allow control of the wealth to be maintained. You can control the trust yourself if you wish, as a trustee, whilst commencing the “seven-year clock” for IHT purposes. Furthermore, by using a discretionary trust, you can control and alter who benefits from your wealth in the future, thereby ensuring flexibility and removing the need for an immediate final decision.
  3. Keeping your will up to date, along with any nomination forms, enables your wealth to be distributed according to your wishes, instead of via strict intestacy legislation (the legislation applied when someone dies without leaving a will). Provide your family or solicitor with a sealed copy of your will if possible. Furthermore, keep a power of attorney registered and on file so your finances and wellbeing can be dealt with in line with your wishes should you lose mental or physical capacity.
  4. Pension funds often fall outside of your estate for IHT calculations, so in some cases the income requirements could be met using your other savings or investments. This is worth considering, given that preserving your pension pot is a simple yet effective way of passing down wealth. Spending other investments or savings should be considered to lower your taxable estate on death.
  5. It is possible to gift assets prior to death to mitigate IHT. In simple terms, and depending on your circumstances, if you live more than seven years from the date of the gift, it does not form part of your estate on death. Do you need to hold all your savings or investments? Are some surplus to requirements? A professional cashflow model will provide you with reassurance before gifting assets, ensuring your chosen lifestyle remains affordable post-gifting.
  6. Make sure you are aware of, and use, your tax allowances. This includes annual gifting exemptions, excess income, nil-rate bands and residential nil-rate bands. These allowances can play a key part in your financial plan; regular early gifting, even smaller amounts, can have a positive impact on the taxable value of your estate.

Spouses often leave all their assets to the surviving spouse on death, commonly referred to as mirror wills. To preserve the best value for your estate and minimise the impact of IHT, would it be worth considering passing growth assets, such as investments, down a generation on first death?

The key point to remember is to start planning – and the earlier, the better. Involving your family is a tried and proven method of helping your wealth become truly inter-generational, without suffering unnecessary, costly taxation along the way.

Please note that this article is intended for educational purposes only and should not be taken as investment advice. The value of investments can go down as well as up and you could get back less than you invested. Investment in funds will not be suitable for everybody and you should make yourself aware of the risks before investing and if you are unsure, you should seek professional advice.
Tax rules are subject to change and taxation will vary depending on individual circumstances.
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