Inheritance Tax: Reliefs, rates and exemptions for families
Statistics from the UK government’s tax office show the amount of Inheritance Tax (IHT) families are paying has soared from £2.9 billion ($3.9 billion) in 2011-12 to £5.2 billion ($7.1 billion) in 2019-20—this in part reflects the rise in asset values since 2008, and in particular skyrocketing property prices in London and the south-east of England.
However, the increase also reflects a different trend—a failure of families to utilise the various IHT exemptions and reliefs available to them. This may be due to a lack of knowledge, or a perception that the ability to carry out IHT planning has been substantially curtailed by the government in recent years.
Interestingly, whilst some IHT planning options have been restricted over time—the use of trusts being one example—other IHT reliefs, such as the Residence Nil Rate Band, have been introduced. In addition, the good news is that there are a still a large number of existing reliefs and exemptions available to shelter wealth from IHT. Examples include:
• Annual gifting allowance—perhaps the most well-known IHT exemption is the annual gifting allowance. This allowance treats gifts of up to £3,000 ($4,100) per tax year as exempt from IHT.
• Outright gifts—an outright gift of more than £3,000 will not attract an immediate IHT charge. Instead, it will be treated, for IHT purposes, as a Potentially Exempt Transfer (PET). Commonly known as the seven year rule, a PET will fall outside the IHT net if the individual making the gift survives the gift by seven years. Should the individual die within seven years of the gift and the gift attracts IHT all is not lost; if the gift is survived by at least three years then the rate of tax begins to taper down on a sliding scale.
• Gifts on marriage or civil partnership—Gifts of up to £1,000 ($1,300) on the occasion of a wedding or civil partnership ceremony will be exempt from IHT. If the gift is by a grandparent or great grandparent then this amount increases to £2,500 ($3,400) and for a parent it increases further to £5,000 ($6,800).
• Gifts out of income—a valuable (and often underused exemption) relates to gifts out of excess income. If an individual's income exceeds their day to day expenditure then any "excess" income given away will be exempt from IHT.
• Gifts into trust—it is still possible to make gifts into trust and avoid immediate IHT charges. Currently individuals can give up to £325,000 ($444,000) into trust without triggering immediate IHT charges, meaning that married couples and those in civil partnerships can gift up £650,000 ($887,000) into trust.
• Business Relief (BR) investments—BR was first introduced in 1976 with the primary aim of preventing family run businesses from being broken up due to the death of a business owner. More recently BR investments have become commonplace for individuals looking to shelter their wealth from IHT. Shares listed on the AIM market qualify for BR, as do EIS investments, provided that the individual has owned them for a minimum of two years.
• Agricultural Property Relief (APR)—APR can also be a useful tool for reducing IHT. APR is available on land that is occupied for the purposes of agriculture, as well as on buildings and farmhouses used in conjunction with that land.
• Gifts to charity—gifts to charity, during lifetime and on death, are exempt from IHT. Further, since 2012 it has been possible to benefit from a reduced rate of IHT on death (from 40% to 36%) if 10% or more of an estate is left to charity.
All of these options can help reduce exposure to IHT, but it's important not to let the tax tail wag the dog—pursuing a particular tax mitigation strategy, while ignoring important financial planning considerations, can ultimately do more harm than good. BR investments are a good example of tax and financial planning needing to work hand in hand; whilst BR is a valuable IHT relief, investment advice is vital to ensure that the investment risks are understood and the right investments are selected.
Equally, with lifetime giving, financial planning is key. I speak to clients who want to make substantial gifts to children or grandchildren to mitigate IHT, but without properly considering affordability. With the input of a financial planner, detailed cash flow modelling can help to demonstrate gift affordability. It can be surprising just how much more (or sometimes less) an individual can afford to give away once the numbers have been crunched.
Pensions are another example where tax and financial planning should work hand in hand. Pensions can pass free of IHT on death, meaning that ringfencing pensions whilst spending capital may be the best strategy to pursue to reduce IHT exposure.
What is clear is that the notion of families having a limited range of IHT planning options to choose from is misplaced. There are plenty of options to consider, and with the right advice families can substantially cut their IHT bill.
