Understanding Inheritance Tax and Estate Planning
Inheritance Tax (IHT) is currently paid by around 4% of UK estates, but that number is expected to increase to around 7% of estates by 2032. IHT is payable on the value of an estate at death and on certain lifetime gifts.
Before starting any IHT planning, an exercise will need to be undertaken to estimate the value of an estate and the exposure to IHT. The amount of the available IHT nil rate bands will need to be determined. It will also be important to have an up to date will in place.
A strategy to reduce exposure to IHT will include the following:
Regular lifetime gifting.
Reducing IHT exposure on death.
Life insurance and will planning.
Regular lifetime gifting
A straightforward but effective IHT strategy is to begin making regular gifts as soon as possible. Regular gifts made could be covered by one of the following exemptions:
Exempt amounts - there is a £3,000 IHT annual exemption, a £250 small gifts allowance and exemptions for certain gifts on marriage.
Potentially Exempt Transfers (PETs) - amounts gifted to individuals in excess of the exempt amounts will be PETs and so if death occurs within 7 years of the gift, the amount gifted will form part of the death estate.
Gifts out of excess income - cash gifts that are ‘made as part of normal expenditure out of income’ may be immediately exempt from IHT. (A record of annual income and expenditure, as well as gifts, should be maintained and a template for recording this is provided by HMRC form IHT403.)
In certain circumstances a gift into a trust will be preferable to an outright gift to an individual (particularly in the case of gifts to minors).
Reducing IHT exposure on death
Certain assets are favoured for IHT purposes as they qualify for Business Relief (BR). After the assets have been held for 2 years, they qualify for 100% IHT relief. Qualifying assets include AIM shares and commercial woodlands. Financial advice should be obtained before investing and there is also always a risk that the qualifying BR status may be restricted or removed.
Uncrystallised pension funds can currently be passed to the next generation free of IHT. However, from 6 April 2027 these will form part of the IHT estate.
Life insurance and will planning
Taking out life insurance does not reduce the value of an estate. However, an annual premium may be paid into a policy which then pays out on death to cover an IHT liability. The policy is generally written in trust so that it doesn’t form part of the death estate.
It is possible to take out whole life cover or term cover. A financial adviser should be contacted to provide premium quotes. A Will should be reviewed regularly and may need to be updated to take account of changes in circumstances. One method of reducing the rate of IHT payable on death is to include a charitable legacy under the terms of a will. The IHT rate on death is reduced from 40% to 36% where 10% or more of an estate is left to charity.
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