In Rachel Reeves’ first budget on the 30th October, she introduced several new inheritance tax (IHT) measures that may affect a lot of you. First and foremost bring pensions, pension death benefits and death in service benefits into the IHT regime for the first time. This is likely to mean that a lot of people who hadn’t even thought they were wealthy enough to pay IHT will now be firmly over the line and their beneficiaries will unexpectedly find themselves subject to the wealth tax.
Shae also changed the way that both agricultural property and business property will be subject to IHT, including AIM shares in estates now, although at a reduced rate.
The changes come into effect in 2026 and 2027, so I wouldn’t be hugely surprised if they look very different by they time they enter legislation. At the moment the way it looks to be set up will mean that those who die over the age of 75 will have their beneficiaries pay both IHT at 40% and income tax on top of that, often at 40 or even 45%. This seems extreme so watch this space for any changes (I myself have contributed to the consultation on bringing pensions into IHT and mentioned this particular unfairness).
So what can we do? Well, as previously mentioned in Newsletters, don’t take any action until you know what the new rules are actually going to be. It could be you take action now that is completely unneeded by the time the legislation is actually passed.
However, having a large pension pass relatively in tact to your beneficiaries is likely to be a thing of the past, so one thing I have been telling clients is make sure you’re actually using your pension for what it was intended for, paying for your retirement, rather than keeping as much as possible in your pension wrapper because it was same from IHT at the time. If you want to know what is a sensible amount to withdraw from your pension then please get in touch now, but we will address it at your next review.
How do we actually reduce out IHT liability?
It has been said that Inheritance Tax is a voluntary levy paid by people who do not trust their heirs!
There are 4 main ways to reduce Inheritance Tax liability but the first thing to do is see if you have an IHT liability or not, if you don’t then you have nothing to worry about. Anything thing passing between spouses (assuming they are both UK Domiciled) is completely free of IHT, so couple generally only pay inheritance tax on second death if they leave everything to each other on first death.
Everybody has a £325,000 Nil Rate Band (NRB) and any unused NRB can be passed on to your spouse. You then have a further up to £175,000 Residence Nil Rate Band (RNRB) which again can be passed on to your spouse (but only up to the value of your home, so if your home is worth £100,000 the maximum RNRB you can claim is £100,000). This can only be used if you are leaving your main residence to your children or other descendants, such as grandchildren, great grandchildren etc… So altogether every single person has between £325,000 and £500,000 free of IHT and every couple has between £650,000 and £1million.
Here are the 4 ways to reduce IHT:
- Spend as much money as you can!
It might sound easy, but its more difficult than you might think. You can’t go out and spend £30,000 on jewellery because all you would have done is replaced £30,000 of cash with £30,000 of jewellery, the value of your estate remains exactly the same. Watch the Richard Prior film Brewster’s Millions to see how hard it is! Spending money on holidays and things that actually reduce the amount of money you have.
- Use your allowances.
You can give up to £250 to as many people as you like and it leaves your estate immediately. You can then give up to £3,000 per calendar year away without the ‘7 year clock’ starting to tick, and for couple’s this is each, so a total of £6,000. If you didn’t use this allowance in the last calendar year then you can bring that forward for a maximum of £6,000 or £12,000 for a couple.
There are also amounts you can give away as a wedding gift, £5,000 to a child, £2,500 to a grandchild or great grandchild and £1,000 to any other person. This is again doubled for couples.
Then you can give away any amount you like as ‘gifts out of regular income’ as long as: you can afford the payments after meeting your usual living costs, and you pay from your regular monthly income.
- Give your estate away.
This is where people usually associate the ‘7 year clock’. If you give away part of your estate, whether that is an item such as jewellery or a piece of art, or you give an amount of money, it does not actually leave your estate unless you survive for 7 years after the date of the gift. There are obvious risks to this, the main one being you shouldn’t gift away anything you can’t afford to and may rely on in later life, you may not want to gift anything to a child that may go through a divorce in the future which effectively gives their future ex-spouse some of your hard earned money, but we can mitigate things like this using Trusts (which themselves have a lot positives and negatives).
There are a lot of things to think about before making a gift, make sure you discuss it with your financial adviser before going through with it.
- Insure against it.
This is probably the simplest way to do it, take out a Whole of life insurance policy that pays whatever your IHT liability is on 2nd death. This means you don’t have to worry about giving money away, however, in reality you aren’t actually reducing your IHT liability, you are simply pre-paying it. Also, Whole of Life policies are significantly mor expensive than life insurance policies you may have had in the past as, as long as you continue to pay the premiums, it is definitely going to pay out the sum assured at some point. For this reason the younger you are the more cost effective these policies are.
Whilst they are relatively expensive, they are excellent value for money as generally you would have to live well into your 100’s in order to pay in what you eventually get paid out, assuming you are healthy when the policy begins, but therein lies the other problem with this strategy: the older you are the less likely you are to be healthy enough to be accepted on normal terms. So some of my client’s have no real hope of being accepted for any kind of life cover due to their current health, so this option isn’t available to everyone. Clients who have a very high retirement income find it particularly useful though as it also helps to stop the estate becoming even higher due to income not being spent.
This is a very high level view of the options you have to reduce inheritance tax, and we haven’t even mentioned thing like Discounted Gift Trusts, asset backed Business Property Relief portfolios and other strategies specifically for reducing IHT, because those are only for very specific circumstances and are not right for everyone.
If you are worried about inheritance at all, contact us and we’ll first work out how significant the problem is, and then what would be a good strategy for your particular circumstances.
And always remember what my dad said to me about IHT:
“Andrew, let me get this straight. I don’t pay inheritance tax, you lot pay inheritance tax. Well, I’ve never been that bothered about how much tax you lot pay!”