The famous dictum that maximising tax revenue is like plucking a goose with the minimum amount of hissing still holds true. No one likes to pay tax. Yet we all agree that it’s important that we do (although we usually prefer someone else to pay more than us). With the tax burden at record highs, it makes sense to look to every legal avenue where you can reduce your tax bill. One major, and expanding, area, is Inheritance Tax (IHT). Previously seen my most as only a tax that the ‘rich’ have to pay, the recent years of frozen allowances, rising inflation and house price growth are all combining to drag more and more people into paying IHT.
The most figures on tax receipts for January show that IHT continues to rise. Total receipts are £5.9bn so far this year, which is up £600m on December and tracking to exceed the 2021-22 tax year by £900m. One of the principal reasons for this is that government has refused to change the thresholds over the years, thus drawing more and more estates above the limits and thus having to pay IHT. Now, families which would not normally consider themselves as well-off are having to pay. The good news is that you can take steps to reduce how much your descendants might have to pay. Think of it as plucking the government without too much hissing on their part…
First, it’s important to consider how IHT works. Basically, it’s a tax on your estate when you die. Your estate is all the assets that belong to you: your money, your property, your businesses, investments and also other things such as wine cellars, cars, art collections, antiques etc.
The government sets a threshold below which no Inheritance Tax needs paid. This is currently £325,000 and it has been frozen (i.e. it won’t increase, which is obviously a bad thing for those inheriting) until 2028. In addition, there is an extra amount that can be used to offset IHT, called the residence nil-rate band. This applies if you leave your home to your children or grandchildren and it too has been frozen until 2028, at a level of £175,000.
Any value in your estate above these amounts is taxed at 40%.
To help reduce the amount your family will have to pay, start planning now. Here are some of the key things you should consider doing…
If you haven’t done this, do it now! Without a will, your estate is shared according to a set of pre-determined rules which will possibly mean the taxman send up with more than its fair share.
For those under 75 years, pensions are not usually subject to IHT and so they can be passed on tax efficiently and, in some cases, even tax free. Check to see if you any pension allowance left and if you do then use of it.
Trusts are a key element of IHT planning. The critical thing though is to establish one as soon as possible, because if you live for a further seven years then Trusts can be used to put money outside your taxable estate. The legislation around this is complicated though and I strongly advise you seek expert advice before doing this.
If you own - or invest in - any business that qualifies for business property relief you can benefit from full IHT relief. You must be a shareholder for at least two years and still be so on death. Most private companies and some AIM-quoted companies do qualify for this, so investigate it now.
As you know, ISAs are tax-free during your lifetime. However, when you die, or when your spouse dies if later, they could be subject to 40% IHT. Many people get confused here because they think ISAs are tax-free. Be warned – they do form part of your taxable estate along with your other savings, investments etc.
One way to mitigate IHT on an ISA is to invest in certain AIM quoted companies which do qualify for BPR (see 4 above). As long as you still own the shares on your death - and have done so for at least two years - you should be able to pass them on without a penny due in inheritance tax.
EIS (the enterprise investment scheme) and SEIS (the seed enterprise investment scheme) offer generous tax reliefs. For example, SEIS offers up to 50% income tax and capital gains tax reliefs, plus loss relief if the investment does not come to fruition. And the better news is that EIS and SEIS investments also qualify for BPR, so could be passed on free of IHT after two years.
This is not much used, but worth considering for experienced investors. Many pension funds and institutions have put a lot of money into forestry. These investments should be free of IHT at death, if held for at least two years. You can also benefit from capital appreciation in the value of the trees and the land they are on and from any income produced when the trees are harvested and the timber sold (even better news - this income may also be tax free).
Please do this. It’s great for families, especially if an older grandparent can help the younger generations gain money for housing, education, etc. Essentially, every year you can give up to £3,000 away tax free in what is known as the annual exemption. Moreover, if you did not use it last year, you can combine it and pass on £6,000! In addition, you can give up to £250 each year to however many people you wish (but you can only give one gift per recipient per year) or make a wedding gift of up to £5,000 to your child, up to £2,500 to your grandchild, up to £2,500 to your spouse or civil partner to be and £1,000 to anyone else. Also, don’t think that’s an end to your generosity. You can pass on as much as you like IHT free - so long as you live for at least seven years after giving money away. There is a sliding scale if you die before this seven-year period, as shown in the table here.
These gifts are immediately IHT free, with no need to wait for seven years and there is no limit on how much you can give away, so long as you can demonstrate your standard of living is not affected.
Leaving at least 10% of your net estate to a charity or a few other organisations means you may be able to get a discount on the IHT rate. This would then be 36% instead of 40% on the rest of your estate.
Tax is complicated. That’s why we’re in business and why M&S prides itself on being a genuine tax specialist and not just an average accountancy firm. We employ people with specific, high level, qualifications in tax and a real passion for the subject (someone has to!). Alternatively, your IFA, if you have one, should be earning his or her fees by providing you with sound advice.
The easiest way to reduce your liability or even to avoid Inheritance Tax altogether is to ensure your tax is under the threshold. While we fully understand (and agree) that most will want to leave some money to their children and other dependants, as you get older it’s time to enjoy life. If you can afford it, it’s maybe time for that round the world trip or the trip to Cheltenham, or the diamond ring you couldn’t afford when you were younger. But again, be sensible and, if you’re concerned about having enough money in retiral, take advice.
Vivian Linstrom, M&S Accountancy and Taxation