The above figures have led Sajid Javid to hint that Inheritance Tax could be scrapped. Having called the record IHT receipts ‘a real issue’, the Chancellor has acknowledged that changes to the tax are ‘on his mind’.
So, is the tax going to be abolished? We look at the Chancellor’s recent comments, provide a brief refresher on the current IHT rules, and outline five common strategies used to reduce an Inheritance Tax liability.
Abolishing Inheritance Tax ‘on the Chancellor’s mind’
At a fringe event at the recent Conservative Party conference, the Chancellor was asked about his views on Inheritance Tax in the light of record Treasury receipts in 2018/19.
Mr Javid said: “I shouldn’t say too much now, but I understand the arguments against that tax. I do think that when people have paid taxes already, through work or through investments and capital gains and other taxes, there is a real issue with then asking them, on that income, to pay taxes all over again.
“Sensible changes have already been made, but it’s something that’s on my mind,” he added.
Since Javid’s comments, a second Cabinet minister has come out in support of reforming or abolishing the unpopular tax.
Communities Secretary, Robert Jenrick, said that IHT was ‘perceived to be unfair’ and argued that the rules are slanted towards the rich because they are able to find financial loopholes around the tax.
He told Sky News: “I can see why the Chancellor is interested in this one.”
The comments follow a report from the think tank Resolution Foundation last year, which concluded that IHT should be abolished and replaced with a new system which would be fairer and harder to avoid. The report called IHT ‘unpopular and unfixable’.
Of course, abolishing the tax would be expensive, as it raised more than £5 billion for the Treasury last year.
A brief overview of the Inheritance Tax rules
Inheritance Tax will normally be payable if the value of an estate exceeds the ‘nil-rate band’ (NRB) threshold of £325,000.
No tax will be paid if:
- The value of the estate is under £325,000
- everything above the threshold is left to a spouse or civil partner
- everything above the threshold is left to an exempt beneficiary (e.g. a charity)
In addition to this, the government recently introduced a ‘residence nil-rate band’ (RNRB). This gives an additional allowance to reduce any IHT liability against a home if it (or a share of it) is passed to children or grandchildren on death.
The RNRB allowance is:
- 2019/20 – £150,000
- 2020/21 – £175,000
- 2021/22 onwards – rises in line with the Consumer Price Index
This means that, in the 2019/20 tax year, there could be a potential combined ‘nil-rate’ allowance of £475,000.
Individuals also have a ‘transferable nil-rate band’. Here, couples can ordinarily apply any part of their spouse or civil partner’s nil-rate band to their own estate.
For example, if an individual left £97,500 from their estate to anyone other than their spouse when they died, it would use up 30% of their £325,000 NRB, which means their surviving spouse could claim 70% of their allowance, giving a total ‘nil-rate band’ of £552,500 (£325,000 + the remaining £227,500).
All this means that, in 2019/20, the maximum that can be passed on tax-free is £950,000 for married couples or those in a civil partnership, or £475,000 for individuals.
- For individuals, this is made up of the existing £325,000, plus the extra £150,000 RNRB
- For couples, when the first person dies their allowance is passed to the survivor, so that £475,000 is doubled to £950,000
5 IHT reducing strategies
1) Gifting from surplus income
This is an IHT exemption which allows ‘gifts from normal expenditure out of income’ to reduce the value of an estate as long as:
- The gift was part of ‘normal expenditure’. ‘Normal' means normal based on an individual's circumstances, and generally means that the gifts need to be regular both in terms of frequency and value.
- The gift was made out of income. Income means earned income, dividends, interest, rental income or pension income. It does not include capital.
- There is sufficient income left to maintain living standards.
If gifts from surplus income are made, it’s important that documents and evidence of the intention to make regular payments are kept. These may be needed as evidence to claim the exemption.
2) Lump sum gifts
If gifts to another person are made during an individual’s lifetime, providing the donor lives more than seven years after the was gift, no Inheritance Tax will be payable on the gift when the donor dies.
Such a gift is called a Potentially Exempt Transfer (PET). If the donor within seven years of making the gift, the PET becomes chargeable and is added to the estate for IHT.
Remember that gifts, where an interest is retained, don’t qualify as a PET. For example, if an individual continues to live rent-free in a house they gifted to their child more than ten years ago, the house would still be considered part of their estate and therefore subject to IHT.
There are several gift allowances that can also be used to reduce an IHT liability. These include:
- The annual gift allowance –assets or cash up to a total of £3,000 in a tax year can be gifted without being added to the value of the estate for IHT purposes
- Gifts up to £250 –unlimited gifts of up to £250 are allowed (just not to anyone who has already received a gift of the whole £3,000 annual exemption)
- Wedding gifts –up to £5,000 to a child, up to £2,500 to a grandchild or great-grandchild, and up to £1,000 to anyone else is allowable.
3) IHT-saving investments
A number of shares listed on the Alternative Investment Market (AIM) become free from IHT once held for two years as they then qualify for Business Relief.
Similarly, Enterprise Investment Schemes (EISs) also benefit from Business Relief and so there is no IHT to pay once held for two years. EISs invest in small, unquoted enterprises and offer upfront tax relief of 30% and, if the investment is held for three years, there is no Capital Gains Tax to pay when the EIS is sold.
It’s important to remember that both AIM shares and EISs are high-risk investments that are not suitable for all investors.
There are strict rules on what qualifies as an AIM stock and the investments can be risky. EISs are very high risk and there is a danger that a large part, or even all, of the capital can be lost. And, as they are illiquid assets, they can also be difficult to sell.
You should always seek advice from a professional financial planner before making any of these investments.
4) Life assurance to pay the tax liability
If an Inheritance Tax liability exists, then some assets may have to be sold when on death to pay the tax that is due. The home or other assets may have to be sold to realise cash to pay the IHT.
One way to ensure any tax liability is met is to take out a life insurance policy. A whole-of-life policy can cover the tax due, meaning that more passes to the beneficiaries.
To ensure the proceeds of the life insurance policy are not included in the estate, the policy should be written in trust.
A whole-of-life policy has a double benefit:
- The proceeds of the policy can sit outside the estate for IHT purposes
- The premium paid for the policy will also reduce the value of the estate whilst the life assured is alive, further reducing the estate's future IHT bill.
If large gifts (Potentially Exempt Transfers) are planned, there specific life insurance policies to cover any potential tax liability on these gifts if death occurs within seven years of making the gift.
As the tax due on a PET reduces over the seven-year period, a seven-year decreasing-term assurance policy can be a good and inexpensive way to cover this potential IHT liability.
5) Gifting to charity
Leaving money to charity can be an excellent way of reducing an IHT bill. That’s because any portion of an estate left to charity (or a university, amateur sports club or museum) does not count towards the total taxable value of the estate.
In addition, if at 10% of the net estate is left to charity, the rate of Inheritance Tax paid will reduce from 40% to 36%.
Important note: This article is for educational purposes and should only be acted on once professional advice has been taken.
If you would like any advice on your Inheritance Tax liability, and how you can leave more of your estate to your beneficiaries, please get in touch.
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