Statistics released by HMRC in September 2019 have shown a record £5.4 billion in inheritance tax (IHT) receipts. The figures, which relate to the 2016/17 tax year, revealed that 28,100 estates paid inheritance tax during the 12 month period. Compared to the previous year, the number of estates liable for IHT increased by 15% and the amount collected rose by 3%.
Under the current inheritance tax rules, receipts seem to be following a consistent upward trend, notwithstanding the introduction of the Main Residence Nil Rate Band on residential property.
Although an increasing number of individuals are finding themselves at risk of an inheritance tax liability, when it comes to taking steps to mitigate IHT, we find that clients aren’t always forthcoming.
Whilst clients generally recognise the reasons behind diverting wealth, when it comes down to it, many clients simply do not want to relinquish control or access to their wealth. Many of the ways to avoid inheritance tax liability involve gifting property or money outright, and surviving the gift by 7 years. Unsure what the future may hold, many individuals and couples in retirement are unwilling to make such gifts.
Here are three ways to plan to mitigate inheritance tax whilst retaining control.
Pass on pension wealth
Since the 55% death tax was scrapped as part of ‘pension freedom’ reforms, beneficiaries of pensions stand to be much better off. Now, if a pension holder dies before the age of 75, they can pass their pension pot on without any tax implications. Where the death occurs over age 75, any income drawn from an inherited pension will usually be charged at the relevant marginal rate of income tax.
As such, pensions are now viewed as one of the most effective ways of passing on wealth. With this in mind, in cases where income can be derived from non-pension savings or investments during retirement, it may be considered sensible to utilise these in the first instance rather than accessing pension funds. In leaving as much of your pension untouched as possible, and completing an expression of wish to nominate your beneficiaries, you can pass pension wealth on to individuals of your choosing without any inheritance tax liability.
With life expectancy now seeing many people live into their 80’s and 90’s, more people entering retirement will still have elderly parents, from whom they may stand to receive an inheritance. Statistically, the typical inheritance age is between 55 and 64. For those teetering on the edge of the IHT bracket or already within it, receiving an inheritance may provide more of a headache. One way to avoid an inheritance increasing your IHT liability is to consider making a deed of variation. A Deed of Variation can be used by a beneficiary who wishes to alter or redirect their inheritance entitlement. The rules around Deeds of Variation stipulate that the variation must be made within 2 years of death. Aside from this, the rules offer a large amount of flexibility – leaving the amount to redirect to the new beneficiaries entirely at the original inheritor’s discretion.
Use of trusts
One method of passing on wealth whilst retaining access and control is utilising trusts with specified access dates and/or ages. Although technically still gifting this money to the beneficiaries, clients using this strategy can retain some control (but not benefit) over the assets. Trusts can quickly become complicated and require professional involvement to set up. The pros and cons of different types of trusts need to be weighed up as those where control is possible incur a tax charge.
Whilst many clients have the desire to create a better life for their children and grandchildren, it is first and foremost a priority that their own needs will be met. Thereafter, it comes down to balancing the factors of control, access and minimising tax – and the varying degree each of these factors matters to each client. Tools such as cash flow modelling can establish whether making lifetime gifts to loved ones is affordable.
It’s worth bearing in mind that although the headline statistics on inheritance tax appear alarming, the number of estates that actually end up being liable to pay the tax is relatively small. In the UK in the tax year 2016/17 around 610,000 deaths were recorded. Of these, 249,000 estates were submitted to HMRC for a review of their IHT status. Of these, just 28,100 estates ended up paying IHT.
The Financial Conduct Authority does not regulate Tax Advice, Trusts or Estate Planning or Cash Flow Modelling.