Ten ways to avoid Inheritance Tax

Over the past decade, the amount of Inheritance Tax (IHT) paid has more than doubled. Figures from the Office for Budget Responsibility shows it rose from £2.4 billion in 2009/10 to £5.2 billion in 2017/18 and around one in 20 estates were liable. Next year, they expect IHT to rise to £5.3 billion. When IHT is largely avoidable, you have to wonder why so many people are falling foul of this unpopular tax?

Worryingly, research conducted by HMRC found that only 45% of people making cash gifts in their lifetime were aware of the potential Inheritance Tax (IHT) implications. Overall, they found knowledge of the rules and exemptions was surprisingly low.

But, before we delve into our top ten ways to avoid paying IHT, here’s a reminder of how IHT works.

Rules and Nil-Rate Bands

The current IHT rate is 40%. There are also two Nil-Rate Bands available, up to which no IHT is liable:

  • Nil-Rate Band (NRB)

The NRB is currently £325,000 and planned to remain so until 2021. The NRB may be increased if you’re widowed or you’re a surviving civil partner, as any unused NRB can be transferred to the surviving partner when the first person dies. This has the effect of potentially doubling the amount of NRB available up to £650,000.

  • Residence Nil-Rate Band (RNRB)

The Residence Nil-Rate Band was introduced to help you pass your home on to family. To benefit from this additional allowance, you must pass your home (or a share of it) to your children or grandchildren. The RNRB is currently £150,000 and will rise to £175,000 in tax year 2020/21. Beyond this, the RNRB will increase in line with the consumer price index.

There is a limitation of the RNRB – if your total estate is valued at more than £2 million. It is tapered away by £1 for every £2 above the £2 million limit. Fundamentally, if your estate is worth over £2.35 million in 2020/21 you will not benefit from the additional allowance.

Mitigating Inheritance Tax

Other than simply spending your wealth, here are our top ten ways to help your beneficiaries paying unnecessary tax:

1. Write a will

Having a valid and up-to-date will is one of the most basic and important estate planning things you can do. Not only does it mean your assets are distributed in line with your wishes, but you can reduce a potential IHT bill also.

Shockingly, according to figures from Royal London, 59% of parents either don’t have a will or have one that is no longer relevant. If you die without a will, your estate is distributed according to intestacy rules, which may be liable to IHT that could have easily been avoided.

2. Leave your estate to your spouse

Your spouse or civil partner will never pay IHT on assets you leave them. If you’re intending to leave your wealth to your extended family, this can be a great method in the interim. Your partner will also ‘inherit’ your unused Nil-Rate bands, so in effect their total IHT exemption threshold can be as high as £950,000.

3. Give assets away

Gifting an asset of any value is exempt from IHT if you live for seven years after. If you die during that time, the value of gifts would be included in your estate.

Regardless of the timescale, during your lifetime you can gift up to £3,000 a year which is immediately exempt from IHT. Known as the ‘annual exemption’, unused allowance can roll over to the next tax year, but no further.

4. Make ‘gifts out of income’

Making gifts out of income is another exemption, but to qualify the gift must form part of your normal expenditure, be made from income and cannot reduce your standard of living. It’s important to keep documentation of income and expenditure as proof.

5. Use a trust

If you place assets in trust, they are nominated to a loved one and are deemed outside of your estate. There are many different types of trust, not all of them qualifying for IHT exemption, so it’s important to get advice when exploring this option.

6. Invest in an AIM portfolio or a Business Property Relief qualifying investment

AIM stands for Alternative Investment Market and shares on this stock exchange qualify for an IHT exemption called Business Relief.

You need to have held the investment for at least two years for it to qualify, but after this period a qualifying AIM portfolio will be 100% exempt from IHT. Furthermore, it is possible to hold AIM shares in an ISA, making them even more tax efficient.

Another solution is to utilise a service that allows the opportunity to invest in the shares of unlisted trading businesses that are having a positive impact on and support the growth of the UK economy, such as companies in the renewable energy, healthcare and property sectors.

Such investments normally qualify for Business Property Relief (BPR) and, as with an AIM portfolio, must be held for at least two years to qualify for 100% exemption from IHT.  It is worth bearing in mind that the value of the investments mentioned here have the ability to go down as well as up.

7. Spend your pension savings last

In most circumstances, pensions are exempt from IHT – they are also often your largest asset. Spending other income sources first during retirement could save your loved ones a significant sum of money. If you pass away before age 75, a pension can be passed to beneficiaries Inheritance and Income tax-free and remain in a tax-efficient pension environment. If you die after age 75, your pension can be paid free of Inheritance Tax as a cash lump sum, but the beneficiary will pay Income Tax.

8. Make a charitable donation

Anything you leave to a UK registered charity is immediately free of IHT. But, if you leave more than 10% of your estate to charity the rate of IHT liable falls from 40% to 36% – a great way to give to a worthy cause close to your heart whilst minimising tax.

9. Take out insurance

If you can’t completely mitigate a potential IHT liability, a life insurance policy can be used to cover the cost. The cover will need to be written in trust, so it is paid to a named individual, otherwise, the payout will be included as part of your estate and increase the IHT liability.

10. Get advice

There is no substitute for professional, expert financial advice. At Novus, we share over 100 years of financial services experience between the team. We build long-term relationships on trust and understand what’s important to you and your family. If you’d like to reduce or completely eradicate your potential IHT liability, we are here to help.

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