Welcome to Hoxton Wealth, the new home of Hoxton Capital

Tax PlanningJuly 19, 2024

How Do I Reduce My Inheritance Tax Liability?

Hoxton BlogHow Do I Reduce My Inheritance Tax Liability?

  • Retirement Planning
  • Tax Planning

Of all the different taxes the UK levies on its citizens, Inheritance Tax (IHT) has to be a contender for the most complicated and misunderstood. While many people are concerned about how much tax their children will have to pay on their estate when they pass away, you might be surprised to learn that just 4% of estates were liable for IHT in 2021.

So does that mean you shouldn’t worry about it? No. Because while those figures reflect the fact that a lot of estates fall below the thresholds (which we’ll get to in a minute), it also shows that many larger estates are putting in place comprehensive plans to reduce IHT. 

And unfortunately, for those estates it does affect, IHT can have a huge impact. Not only that, but HMRC estimates that the number of estates liable for IHT will increase to 7% by 2033.

It’s also worth noting that IHT is one of the few taxes that the new Labour government hasn’t expressly ruled out increasing. There are persistent rumours that we will see changes to the tax, which makes long term estate planning more important than ever.  

For people with a global footprint and assets in multiple countries, navigating IHT can be a challenge. In this article, we’re going to cover whether you fit into the group that may be looking at a big IHT bill, and if so, how you can reduce inheritance tax for your descendants.

Inheritance Tax Primer

Can inheritance tax be avoided? Before we get into ways to reduce inheritance tax, we need to understand how it works and who has to pay it. It’s worth noting that IHT is a very complex area. In this article we’ll be covering the main points, but there are many exemptions and limits that may apply to individual circumstances. It’s why personal IHT tax planning advice is always highly recommended.

  • Who pays inheritance tax?

    If you’re a UK citizen with a UK domicile, IHT is calculated on your worldwide assets. It’s important to note that domicile is different to residency, and the distinction can be very grey. Generally speaking, if you were born in the UK or lived there for more than 15 years, you will be classed as a UK domicile.

    For married couples, IHT is typically calculated on a combined basis. When the second person in the couple passes away, it is generally at this point when IHT is calculated and the executor of the estate is required to make payment to HMRC. 

  • How much is inheritance tax?

    Everyone has a tax free amount (known as a Nil Rate Band) of £325,000. Any estate worth less than this (per person), is free of IHT.

    There’s no specific property inheritance tax, and in fact there is actually an additional Residence Nil Rate Band (RNRB) for homeowners of £175,000, as long as the property is worth at least this amount. 

    That means that for a couple who own a home worth at least £350,000 (2 x £175,000 RNRB), they can have a total estate of £1 million before being liable for any IHT. To benefit from the RNRB the beneficiaries must be direct descendants and the allowance is tapered down where the estate is over £2 million in value.

    For any amount over these thresholds, IHT is charged at a rate of 40%.

    So, for example, an estate worth £1.1 million would only be liable for IHT on the £100,000 over the Nil Rate Bands (NRB), meaning there would be a IHT bill of £40,000 payable by the estate to HMRC.

    There are also some notable exceptions to this, with pension assets being the most common. As pension funds are technically held in trust, pension assets are not liable for IHT, no matter how large the balance.

  • Will IHT be abolished?

    It’s very unlikely that IHT is going to be abolished, particularly under a new Labour government. If anything, we can expect IHT to become broader, with fewer ways to reduce the impact and more estates falling within the thresholds.

  • Why are more estates becoming liable for IHT?

    In simple terms, asset values are growing at greater rates than the nil rate bands. The current NRB of £325,000 hasn’t changed since 2009. If adjusted each year for inflation, the current should now be over £500,000.

    While the introduction of the RNRB in 2017 has somewhat offset this, stock prices and property values have increased well in excess. 

6 Ways to Reduce Your Inheritance Tax Liability

As you can see, there’s a lot of detail in the way IHT works. The good news is that this complexity means there are plenty of planning options to reduce inheritance tax legally. Here are a few of the most well known strategies to reduce your estates IHT exposure:

  • Gifting

    The simplest way to reduce your IHT bill is to reduce your estate through gifting. You can give any amount you want, but gifts over the £3,000 annual gifting allowance (per person), are what’s known as Potentially Exempt Transfers (PETs). They get this name, because when the gift is made, they start what you may have already heard referred to as the ‘7 year clock.’

    If you survive 7 years after making the gift, it is exempt from IHT. If you don’t, the value of the gift is added back to the estate for the IHT calculation, on a sliding scale based on how many years it’s been.

    As well as the annual allowance of £3,000 per person, there are also a number of smaller allowances such as the ability to make regular gifts for things like birthdays and Christmas, as well as some specific exemptions for wedding gifts for immediate family.

    Lastly, there is no limit or 7 year clock for gifts that are made out of regular income. So, for example, if you have income streams that pay you £100,000 per year and you genuinely only need £75,000 per year for your own living expenses, you can gift the £25,000 and have it fall immediately outside of your estate. 

  • Pensions

    As mentioned earlier, pension assets are exempt from IHT. For investors who have other assets they can rely on for their living expenses in retirement, it often makes sense to retain pensions until later in life for this reason. However, this isn’t always appropriate, so it’s an area where personal financial advice is highly recommended.

  • Trusts

    Trusts aren’t a silver bullet, but they can be a useful tool for investors who aren’t prepared to gift large amounts of money to their family just yet. A trust can be created with children or others as beneficiaries, and you as a trustee. Gifts can then be made into the trust, which starts the 7-year clock, but the trustees retain control over how the funds are invested and distributed.

    There are even some trust types which allow you to retain some limited access to the funds in the event that you need them in the future.

    Trust rules are very complex, and if done incorrectly, gifts into trust can be classed as Chargeable Lifetime Transfers (CLTs), rather than PETs. This can potentially result in an inheritance tax bill being levied immediately, so it’s a mistake you want to avoid!

  • IHT-friendly Investments

    There are certain types of investments that are exempt from IHT if they’re held on death and for at least two years. There are many different assets that can fall into this category, with some of the most common examples including:

    • Ownership in private companies
    • AIM-listed equities
    • EIS & SEIS investments
  • Charitable Giving

    A gift made in your Will to a charity or qualifying community organisation (like a grass roots sports club) is automatically removed from your estate value for IHT purposes. If the charitable gift is at least 10% of your net estate (the amount over the IHT threshold), it also reduces the overall IHT rate you pay from 40% down to 36%. 

  • Whole Life Insurance

    Once the various gifting, trust and investment options have been exhausted, it might not be possible to reduce an IHT liability down to zero. A strategy that can be used here is to take out a whole life insurance policy to cover the potential IHT liability.

    The cost of the policy should be weighed up with the benefit it will provide, and it’s also important to ensure that the beneficiary is set up to pay into a trust in the correct way, to avoid the sum insured simply being added to the estate.  

Don’t Go Without a Will

The importance of a Will can’t be overstated. If your estate is over the IHT thresholds, and you don’t have a Will, stop reading right now and call a solicitor. Don’t have one? We can help. The point is that many of the strategies and rules outlined in this article rely on a Will being set up correctly.

If you already have one, but it’s not been updated in years, you should have it reviewed. There have been numerous changes made over the years to legislation, which makes the way many older Wills have been set up no longer correct.

The Importance of Professional Advice in Reducing IHT

This might all seem like a lot, but the truth is this article only just scratches the surface when it comes to IHT planning. Even for straightforward family situations and assets, there are many different strategies that can be used to help reduce inheritance tax.

And if you have assets in multiple countries, the potential to be non-UK domiciled, or a blended family situation, the complexity increases exponentially.

In short, can inheritance tax be avoided? Yes, or at least drastically reduced. However, you need to seek professional advice, and given the time frames involved in PETs, the earlier you seek this advice, the better.

It’s possible to put in place a plan to reduce your potential IHT liability, while also staying in control of your assets and ensuring you have enough money to fund your own lifestyle in retirement. The key is getting the right advisors to help you.

How Can We Help You?

If you would like to speak to one of our advisers, please get in touch today.

“I have had a great experience with Hoxton capital. Izzy was really supportive an...”

Carl

16, August

“My experience was great.
People took time to explain. There was no pressure. ”

Andrew Glossop

15, August

“From the beginning of our relationship, Hoxton guided us all the way, supporting...”

DazMac

11, August

“The Professionalism and Dedication of Jack Reed and the Team. Jack Reed is an exemplar in the field of financial advice and wealth management...”

Mann, Sam

09, August

About Author

Hoxton Wealth

July 19, 2024

Contact Hoxton Wealth

Contact us today to discover how Hoxton Wealth can help you achieve your financial goals. Together, we can build a brighter financial future.