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Inheritance Tax Planning

Inheritance Tax Planning Guide UK

Inheritance tax planning can often be a sombre subject. However, with our inheritance tax planning advice, you can rest easy knowing your loved ones will be able to benefit from your estate tax-efficiently.

It is essential that you take control of the situation and proactively take measures to preserve the value of your assets which will be bequeathed to your beneficiaries. Procrastination regarding this matter may cost you money in the future.

In this inheritance tax planning guide, we will discuss the basics of inheritance tax, the predominant strategies to mitigate inheritance tax liability, and how we at PD Tax consultants can assist you.

PD Tax Consultants have a wealth of experience as inheritance tax planning advisors and have navigated many challenging scenarios for clients. For more information, please see the example case study at the end of this page.

What is Inheritance Tax?

Inheritance tax is levied on the valuation of an individual’s estate following their death. The valuation takes into account worldwide assets including property, possessions, business interests (e.g. shares), and money – minus any debts.

The standard rate of taxation is 40%. A lesser rate of 36% may apply if you leave at least 10% of your estate to charity.

Inheritance Tax Planning Strategies

Depending on your specific circumstance, one of these effective methods of lowering your inheritance tax liability may be applicable to you.

The importance of guidance from expert tax advisors throughout any of the processes laid out below cannot be overstated. Please feel free to contact a member of our team today.

1. Valuation of your Estate

The first step in mitigating inheritance tax is to discover how much inheritance tax you would be liable for if you died today.

Essentially, you include the value of all your worldwide assets as mentioned above, including:

  • Property
  • Business Interests (e.g. shares)
  • Cash
  • Possessions
  • Any other relevant assets

You then deduct any debts or expected funeral expenses. The resulting figure will reflect the valuation of your estate at this time and can provide insight as to the amount of inheritance tax you may be liable for.

2. What Allowances or Reliefs Exist for Inheritance Tax?

Nil-Rate Band - The government issue every taxpayer with a “nil-rate band” of £325,000. This means you are not required to pay inheritance tax on the first £325,000 of your estate.

Resident Nil-Rate Band - An additional nil-rate band of £175,000 exists for those who are passing their family home to children, grandchildren or other descendants called the “residence nil rate band” which acts in conjunction with the standard nil-rate band.

Business Relief – This relief applies to the value of a business or its assets (e.g. machinery) which have been owned at least two years when calculating the inheritance tax liability. A relief of 50% or 100% (of the market value) will be applicable for qualifying assets. This relief can be passed on while the owner is still living or via the owner’s will.

There are several disqualifying factors, so care should be taken to consult expert tax consultants such as PD Tax Consultants

Agricultural Relief – This relief applies where your estate includes a farm or woodland area. This portion of the estate can be passed down inheritance tax-free (or at 50% relief in some cases), either during your lifetime or as part of you will. It must have been owned for two years by the owner, or 7 if occupied by someone else.  

There are several qualifying and disallowed examples of agricultural property, and, as such, careful consideration and expert tax advice should be considered to mitigate any potential pitfalls.

3. Factoring in Nil-Rate Bands and Relevant Reliefs

Once you have an accurate valuation for your estate, you can apply the nil-rate band of £325,000 and, if you are bequeathing your estate to family, potentially the resident nil-rate band of £175,000.

The remaining figure, after any reliefs, is the amount your estate is liable for inheritance tax, at the standard rate of 40%.

You can use the inheritance tax calculator GOV.UK provide to calculate this figure to determine the amount of inheritance tax your estate may be liable for.

4. Drafting a Will

Once you are aware of your inheritance tax liability, it is important that you ensure you draft a Will using reputable inheritance tax planning solicitors.

The main purpose of drafting a will is to distribute gifts and adopt strategies such as setting up trusts which will reduce your inheritance tax liability.

5. Making Gifts

Gifting portions of your estate may also be a tax efficient way to avoid inheritance tax, as gifts between spouses or civil partners who live in the UK permanently are exempt from inheritance tax.

For those gifts which are taxable, there exists a £3,000 annual exemption, which can be brought forward for one year, and one year only, when unused.

This is noteworthy, since HMRC only consider gifts for inheritance tax purposes if you live for 7 years after giving them. Therefore, you can make use of your nil-rate band of £325,000, and the potential maximum of £6,000 in annual gift exemption, to transfer £331,000 of your estate tax free every 7 years.

However, if you die before the 7 years expire, you may be required to pay tax on these gifts. However, you will likely be eligible for “taper relief” which progressively reduces the rate of taxation for gifts between 3 and 7 years before the time of death. As such, it is vital that you acquire inheritance tax planning specialist advice to ensure you do not overpay on your inheritance tax bill.

6. Leave Money to Charity

The standard rate of taxation for inheritance tax is 40%. However, if you leave 10% or more of your estate to either a UK charity, Community Amateur Sports Club, or political party, the rate of taxation becomes 36%.

This may not seem significant; however, below is a hypothetical situation to demonstrate how this can benefit you:

Mr A has an estate worth £2,325,000. After nil-rate bands, Mr A’s estate is liable for inheritance tax at 40% of £2m which is a liability of £800,000.

However, if Mr A donated 10% of his estate to Battersea Dogs & Cats Home (a UK charity), the remainder of his estate would be valued at £2,092,500 (90% of £2,325,000). The amount liable for inheritance tax at 36% after the nil-rate band is applied would be £1,767,500 which is a liability of £636,300.

In summary, utilizing the reduced rate of taxation (36% as opposed to 40%) when leaving 10% of your estate to charity lead, in this case, to a saving of £800,000 less £636,300 which is £163,700.

 7. Leaving Money to a Spouse

Any inheritance received by your spouse or civil partner will not be liable to inheritance tax. This can therefore be an effective way to avoid inheritance tax.

Moreover, if your estate is valued at less than the threshold for the nil-rate band (£325,000), any unused threshold can be added to your partner’s or spouses’ threshold following your death.

8. Trusts

Trusts for inheritance tax planning can be a complicated subject. Simply put, the “settlor” puts assets into a trust; the “trustee” manages the trust; and the “beneficiary” benefits from the trust.

Transfers into trusts are called “chargeable lifetime transfers”, which means that any amount in excess of your nil-rate bands will be charged at 20% upon transfer. Moreover, if you die within 7 years of transfer, the amount exceeding your nil-rate bands will be charged at the full 40%.

The main types of trust include:

  • Bare trusts
  • Interest in possession trusts
  • Discretionary trusts
  • Accumulation trusts
  • Mixed Trusts
  • Settlor-interested trusts
  • Non-resident trusts

The main two, for purposes of minimising inheritance tax, are bare trusts and discretionary trusts.

Bare Trusts – This is a very basic form of trust and is relatively easy to set up. The beneficiaries become entitled to the assets of the trust upon the age of 18 (16 in Scotland). This trust is particularly appeal to parents/grandparents wishing to leave their assets specifically to children or other minors.

Tax Charges:

  • Entry Charge - Provided that you survive 7 years after the transfer to the trust, there will be no tax liability.

There are no other charges aside from income tax on any income generated from the trust by the beneficiary. However, there is a lack of flexibility in bare trusts, as the beneficiary is fixed once the trust is set up. Furthermore, at age 18 (16 in Scotland), the beneficiary has the right to all the trust’s capital and income.

Discretionary Trusts - Discretionary trusts have more layers. The trustees have the power to control the trust income and capital at their discretion, and can decide what, who, and when regarding payments and any conditions to impose on the beneficiaries.

Tax Charges:

  • Entry Charge – Provided that you survive 7 years after the transfer, there will be no tax liability.
  • Principle Charge – The 10-year charge is charged on the decennial anniversary of the trust based on the valuation of the trust’s assets the day preceding the anniversary. The calculation of the rate is complex and is governed by IHTA 1984 s. 66.
  • Exit Charges – This charge is generally up to a maximum of 6% on the transferred assets.

9. Family Investment Companies

Following the 2006 change regarding lifetime transfers into trusts which taxed the excess of a transferor’s nil-rate bands at 20%, Family Investment Companies (FICs) have grown in popularity in comparison to trusts.

A FIC is a standard company where the shareholders are family members. The company is structured such that parents retain control whilst growing wealth outside of their estates to pass down the generations.

The main benefit of a FIC is that any money transferred into a FIC is classed as a “partially exempt transfer” which means any amount you transfer will fall outside of your estate for inheritance tax purposes if you survive 7 years from the date of transfer. This is different from the chargeable lifetime transfer that applies to trusts.

10. Pensions

This can be an effective way to tax efficiently transfer wealth to your beneficiaries. The pros and cons of using a pension scheme to mitigate inheritance tax liability can vary vastly depending on the type of pension scheme, the age/health of the pension scheme owner, and the method by which the pension is inherited.

In essence, inheritance tax is not usually paid on a lump sum because such a payment is usually “discretionary” – i.e. the pension provider can choose whether to pay it to you. However, the finer details of using pension schemes can be complicated and would require discussion with expert tax advisors or an IFA advisor.

How Can We Help?

We at PD Tax can provide you with a wide range of bespoke inheritance tax solutions, such as:

  • Making gifts tax efficiently,
  • Detailed valuations of estates,
  • Will review services and collaboration with inheritance tax planning solicitors,
  • Tailored tax planning for your estate (including Family Investment Companies, trusts, and leaving money to a spouse/charity).

Advice on inheritance tax planning will inherently depend on the nature of the assets involved (i.e. property, cash, or business interests) and, most importantly, your preferences for how and when your estate should be passed on.

Why Choose PD Tax?

A wide range of loyal clients trust PD Tax to deliver the best possible service.

Contact

If you feel that the information above has some relevance for you, and you wish to begin your planning for your legacy to mitigate future inheritance tax liabilities, please contact a member of our team.

The Problem

A landlord was keen to transfer his rental property portfolio to his children during his lifetime in order to mitigate inheritance tax, but was concerned that there may be significant capital gains tax implications on disposal.

The Solution 

After considering a number of different options, we concluded that a family trust route would be the most appropriate and tax efficient way to help our client achieve his goals.

This involved an outright gift of properties to the value of the annual exemption, meaning that no capital gains tax was chargeable on transfer.

We then arranged for our client and his wife to gift into trust the properties up to the value of their nil rate bands. The properties with the lowest gains in proportion to their value were transferred first so that they could benefit from an uplift in base cost, thereby reducing the capital gains tax liability on a future sale.

As our client intended to continue managing the properties, we suggested that he establish a property management company owned by him and his wife. They could then charge management fees to the trust and rental profits will be available through dividends.

The Result 

Provided that both clients survive seven years from the date of gift, the properties will be outside of their estates and they will have saved Inheritance Tax of approximately £260,000.

By extracting rental profits via a property management company, our client will continue to profit from the properties without invoking any anti-avoidance measures.

The Problem

The Will of a deceased’s estate with gross assets over £5 million contained complex provisions for determining the charitable legacy to be paid by the executors of the estate.

The executors and solicitors administering the estate needed assistance to determine the amount of the charitable gift.

The Solution 

After carefully examining the terms of the Will and the principles of the cases of Re Benham and Re Ratcliffe, we concluded that grossing up was not necessary to calculate the size of the residuary legacies and in particular the gift to charity.

As the charitable gift was more than 10% of the net estate, the reduced rate of IHT of 36% could be applied, saving the estate £170,000.

We also identified that a number of shares had been sold at undervalue and that loss relief could be claimed, saving a further £10,500.

The Result 

After finalising our calculation and the inheritance tax return, it became apparent that the estate had already overpaid inheritance tax and was, in fact, due a refund. HMRC duly issued a probate summery to the estate and the refund was issued shortly thereafter.

Contact us today to discuss your tax requirements.
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