There has been a lot of murmuring in the press and Parliament this year about the Conservative Party giving serious consideration to the abolition of Inheritance Tax (“IHT”) which is levied on the value of your estate when you die, at the rate of 40% if its value exceeds the exempt amount which can vary between £325,000 and £1m, depending on marital status and the ownership/value of your home.
This is widely perceived to be a political move and not fiscally motivated. IHT has become more lucrative for the Government over recent years owing to the freezing of the basic exemption which has been at £325,000 since 2009/10, but the tax still “only” raises £7bn per year, compared to the £6-7bn which the freezing of the income tax rates and allowances raised in tax during just the first two months of the current tax year. IHT is only paid by 4% of the population, the majority of whom are brought into the net by the value of their homes, particularly in the Southeast. The current suggestion is that its abolition should be included in the Conservative manifesto for the next general election, presumably in an attempt to encourage those who think that they might be affected by the tax to carry on voting for them, and on the basis that most of those who are in favour of IHT won’t be voting for them anyway. Of course, manifesto promises will be viewed with the appropriate level of cynicism, particularly in the light of the current atmosphere surrounding political honesty in general, so it is certainly not time yet to relax efforts to reduce exposure to IHT.
People who are worried about falling into the IHT net should consider taking action to avoid this, and the first step is to work out the value of your estate to see if it is likely to be covered by the exemptions. If there is a potential tax bill, there are strategies that you can use to mitigate this, such as:
1. Giving money away if you think that it will not leave you short in retirement. Gifts made during lifetime are not counted in the value of your estate after 7 years, and the rate of tax on them is reduced gradually after 3 years. Therefore the sooner this is done the better.
2. Giving away income that is in excess of your living requirements. This would need to be done regularly each year and records should be kept demonstrating that your income after tax is more than enough to maintain your lifestyle. This is particularly useful if you have a generous occupational pension which you are not spending in full and are therefore adding the excess to your estate each year.
3. If you inherit money, this can be redirected to your children (or other family members) using a deed of variation so that it never comes into your estate and the redirected gift will not fall into the 7-year regime. This is a good strategy for those who are comfortably off and inherit from their parents, and who wish to help out their children. The deed must be drawn up formally within two years after the date of death.
4. If you have a life assurance policy, make sure that it is written in trust so that the proceeds pass straight on to your beneficiaries without being included in your estate on death.
5. Consider making use of the IHT exemptions for pension schemes, but make sure that you get good advice from a reputable authorised financial adviser before making any decisions.
6. Consider investing some of your money in a tax-approved small business fund which will be exempt from IHT after 2 years (as well as generating an income tax refund). Again good financial advice is essential here.
7. If you are relying on the exemption for businesses to keep the value of your company out of the IHT net, make sure that there is nothing in the balance sheet that might cause this to be lost such as a property that is no longer used in the trade, or cash in excess of the requirements of the business.
More complicated strategies are available, many involving trusts, and professional advice should be taken if these are to be considered.
Alternatively the “spending the kids’ inheritance” strategy may have some attraction, although care still needs to be exercised to ensure that you will have sufficient funds to last into what will hopefully be a long retirement. A long-term financial plan drawn up with the help of a qualified financial adviser will help to give you reassurance in that direction.
Author: Louise Berry, Tax Manager
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Date published: 28 September 2023