How to cut your inheritance tax bill

The amount paid in inheritance tax (IHT) reached a record high last year, with over £5.2bn being paid. Yet whilst death and taxes are inevitable, IHT has been called the ‘avoidable tax’ or the ‘voluntary tax’ as with some careful inheritance tax planning there are many ways to avoid it or at least reduce it significantly.

Inheritance Tax in its current form was introduced in 1986, when it replaced the Capital Transfer Tax. However, the earliest death duty came into effect in 1694, when probate duty, a tax on personal property in wills proved in court, was introduced. Several inheritance taxes superseded this, including the 1796 tax introduced to help fund the war against Napoleon. However, modern inheritance tax really started in 1894 when the government introduced estate duty, a tax on the capital value of land, in a bid to raise money to pay off a £4m government deficit.

When first introduced, the tax was intended to affect only the very wealthy, but the rise in the value of homes, particularly in the south-east of England, has brought more and more families into the net.

The threshold for IHT has been pegged at £325,000 since 2009 and whilst house price rises have exacerbated the IHT problem, exposing more people to IHT at the 40% tax rate, 2015 saw the introduction of the new ‘family home allowance’. By 2020/21, this will allow each individual homeowner to pass on a further £175,000 of their main home to children or grandchildren on top of the standard allowance. This means that by 2020/21 an individual homeowner will have a tax free allowance of £500,000, whilst a couple could pass on £1 million free of inheritance tax.

The family home allowance obviously helps but the rules are fairly convoluted. Further, for those with large estates valued at £2 million or more, homeowners will lose £1 of the family home allowance for every £2 of value above £2 million.

Indeed, the whole area of IHT planning can be very complex, so it can make sense to seek financial advice and to carry out some proper inheritance tax planning, if you believe you will fall into the IHT net. This should begin with revisiting or setting up a will, to ensure that your affairs are dealt with in a tax-efficient way and that your wishes are carried out.

After that, there are several steps that you can undertake, starting with taking advantage of exemptions, such as your £3,000 a year annual allowance, plus the small gift exemption, which allows you to give up to £250 to as many people as you like. There are also wedding gifts and donations to qualifying charities that you can make, along with gifts out of any excess income.

Beyond gifts, you can consider more complex options, such as taking out life cover, looking into business property relief and also using trusts and/or a deed of variation, which can be designed to meet your individual circumstances and objectives. Bear in mind that tax rules can change and any benefits depend on personal circumstances.

A couple of other options for consideration too. Firstly, it’s possible to create an IHT free ISA, as some AIM shares can qualify for an IHT exemption after two years. This applies even if the ISA proceeds are paid to someone other than your spouse or civil partner when you die. Obviously, AIM shares are a higher-risk investment, so you may want to get personal financial advice before investing.

Secondly, you may want to consider your pensions, as under the new pension freedoms, it is possible to pass on pension assets outside of your estate for IHT purposes. Pensions are now normally tax free on death before 75. After 75, beneficiaries are charged their marginal rate of income tax when taking the money. So basic rate taxpayers will pay 20% for withdrawals that stay within the basic rate tax band, which is obviously half the IHT rate - and, in some cases, they could pay no tax at all.

Tax rules and benefits are constantly changing, so getting specialist advice on IHT could well make sense.

If you believe you may fall into the inheritance tax net and wish to avoid this ‘voluntary tax’, why not get professional advice and talk to Kellands? We look forward to hearing from you.


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