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Inheritance Tax planning – the basics

With big increases in the number of families expected to be hit by Inheritance Tax bills, it is more important than ever to understand the options available to investors when planning their estates.

This blog is aimed at qualified financial advisers. It should not be construed as financial advice and it should not be used as the basis for any investment decisions. Investments with Oxford Capital should only be made on the basis of our full Information Memorandums and application documents.

According to a recent report published by the Office for Budget Responsibility (OBR), almost three times as many estates will be paying inheritance tax (IHT) this year when compared with just six years ago. As a result of rising property prices, combined with a ‘frozen’ nil rate band, over 45,000 families are expected to pay IHT in 2016/17 – exceeding levels last seen in 1979/80.
With 8% of death estates expected to suffer IHT in 2016/17, collecting £4.6bn for HMRC, estate planning will once again need to form an integral part of many clients’ long-term financial planning.

The impact of inheritance tax

In simple terms, if the total value of all assets including the family home is greater than the £325,000 nil rate band, then IHT will be payable on death.

The situation is slightly different for married couples and civil partners. When the first individual dies, their assets can pass to the surviving individual free of IHT. The surviving individual also effectively inherits their partner’s nil rate band, doubling to £650,000 the amount that can be passed to the next generation without suffering IHT.

The value of an estate which exceeds the nil rate band is subject to IHT at 40%.

Table 1 – Amount of IHT payable


* assumes the nil rate band on first death is passed to the survivor

Summer Budget 2015 – Understanding the new Residence Nil Rate Band rule

The introduction of a new ‘residence’ nil rate band, applicable only to the main residence, will provide some respite – at least in the short term. Phased in at £100,000 from April 2017, and reaching £175,000 in 2020 (£350,000 for married couples and civil partners) this new relief will enable greater wealth to be passed to direct descendants without paying IHT – £1m in the case of married couples / civil partners. The new relief is reduced by £1 for every £2 of value in excess of £2m.

The OBR anticipate that as a direct result of this change, in 2017/18 the amount of IHT collected will initially fall by one-third to 30,000 families, or 5.4% of death estates. By 2020/21, this figure will have risen to 6%. Despite the forecast reduction in the overall number of families affected, it is expected that the tax raised on estates will continue to gradually increase, reaching £5.6bn by 2020/21.

Inheritance tax planning – the main options
With IHT expected to remain an unwelcome beneficiary of many estates, the need for prudent planning remains. Fortunately, there are a number of estate planning strategies available which have been developed with the aim at ensuring the efficient transfer of wealth between generations. These generally fall into three categories:

Diagram 1: Three pillars of estate planning

In an ideal world, clients would be receptive to the concept of estate planning at an earlier age, allowing them to access any of these options should it meet an identified need or objective.

Unfortunately, as age increases or health deteriorates, a number of these options may no longer be viable.

Utilising available reliefs and allowances
Holding assets that qualify for relief from IHT can provide significant tax savings. This area of planning has grown in popularity in recent years as it allows the client to retain the full enjoyment of the asset. Examples include:

  • Business Property Relief (BPR) – providing relief at 50% and 100%, depending on the nature of the assets held, BPR is available on business assets that have been owned for at least two years and are held on death. A number of investment management firms have developed investment opportunities designed to help people to access the benefits of BPR.
  • Agricultural Property Relief (APR) – available on assets used for the purpose of agriculture, APR is available at 50% and 100%. Where occupied personally, the asset must have been owned for two years. If owned, but farmed by others, the ownership requirement increases to seven years.
  • Woodlands Relief – this is a special relief that only applies to the growing of timber and only applies to the value of the timber. The land occupied may qualify separately for APR
  • Pension – whilst historically not commonly regarded as an estate planning solution, recent changes have significantly increased the appeal of pensions as a means of transferring wealth between generations tax efficiently.

Lifetime gifting
Often a popular choice with both advisers and client, gifting could simply comprise the transfer of assets direct to a beneficiary or, where greater control is required, involve the creation of a trust.

When making a gift, it is important to establish the value of the assets being transferred. A transfer of value will fall into three distinct categories:

  • Exempt transfers – these are immediately outside the estate and include transfers between spouses and civil partners, gifts of up to £3,000 per tax year and gifts out of normal expenditure.
  • Potential exempt transfers (PET) – whilst no IHT will be payable when the gift is made, in order to remain exempt, the donor must survive seven years. Depending on the value of the gift taper relief may be available after three years. Examples of PETs include outright gifts to individuals, together with transfer into bare trusts and disabled trusts.
  • Chargeable lifetime transfers (CLT) – where a transfer is neither exempt nor a PET, it will be treated as a CLT. Where the value of a CLT, when combined with other CLTs made in the previous seven years, exceed the available nil rate band, IHT will be payable at 20% (increasing to 25% when paid by the donor). Transfers being made into a discretionary trust or interest in possession trust will be treated as a CLT.

As the process of gifting involves removing value from the donor’s estate, it is important to consider the impact this will have on their long-term financial security.
In addition, it is important to avoid any ‘reservation of benefit’ as this will render the planning ineffective. Consideration must also be given to the Pre-Owned Asset Tax (POAT).

Life assurance held in trust
Effective at the point cover ‘goes on risk’, life assurance held in trust provides clients with a non-contentious way of providing a tax-free lump sum on death from which to meet any liability. Whilst the sum assured is tax-free, the premiums paid will be regarded as a transfer of value.

This option is particularly useful where, for a variety of reasons, it is not possible to reduce the size of the taxable estate. Typically arranged on a ‘whole of life’ basis, there may also be occasions where term assurance may be appropriate, for example, alongside gifting or to protect an estate ahead of the new residence nil rate band coming into force.

Designing a solution
As with all financial planning, any recommendation must be based on a thorough understanding of the client’s circumstance. In the case of estate planning, this can often be improved by including other family members in the process as they are often the intended beneficiaries.

When designing a recommendation there are a number of key point that are worth considering:

  • Be realistic – an estate planning recommendation should always ensure that the client continues to enjoy financial security and an acceptable lifestyle.
  • Consider the probability of success – as many of the solutions available take a period of time to be fully effective, it is important to consider whether, given the client’s age and health, they are likely to live long enough to achieve any savings
  • Incorporate flexibility – we live in an uncertain world. The need for flexibility may arise from a change in the client’s personal or financial circumstance. It may also result from external factors, such as changes in legislation.
  • Diversify at a product level – by incorporating a number of solutions into a recommendation it may be possible to improve the level of flexibility, whilst mitigating the impact of any change in legislation.

With IHT likely to remain a concern for many families, the opportunities for estate planning should be reviewed with clients on a regular basis.