The Inheritance Tax (IHT) Nil Rate Band (NRB) is the amount of an individual’s estate that is not subject to IHT. The amount has not changed for almost ten years, remaining at £325,000 since 2009. With many estates now exceeding this, to reduce your Inheritance Tax liability you must plan early.
Admittedly, we have had some changes introduced in relation to transferable NRBs between husband and wife and civil partners, and we currently have the phasing in of the Additional Main Residence Nil Rate Band (read more here: Estate Planning and Inheritance Tax (IHT)) but this doesn’t affect everybody.
We are in a different world than 10 years ago with the size of peoples’ estates having grown significantly and therefore the amount of IHT being paid has substantially increased.
According to HMRC statistics, the number of people with estates worth over £1million has almost doubled in the last ten years, whilst the NRB continues to remain at the same level – bringing more and more estates into the IHT net and increasing the potential IHT liability of those with growing estates.
Where does the IHT revenue come from?
House price growth has been part of this; we have also had a bull market for around a decade; and if income exceeds outgoings, this also leads to wealth accumulation.
Consequently, Government revenues from IHT are predicted to grow exponentially in the future. According to HMRC, those with estates over £1million already pay around three times as much IHT in total as all the estates worth under £1million (up from twice as much in 2009).
Some would argue that more IHT is a good thing… more Government revenue to go on schools, hospitals etc. But is it fair that after working all their lives and paying taxes, taxpayers’ estates may need to be broken up on death to pay yet another tax. IHT is clearly double taxation at its most severe as it taxes assets that have been built up out of taxed income!
What’s the answer?
Indexing the NRB to inflation would be a start, as is the plan from April 2021, but that would be 11 years since the last rise in the NRB. Indexing to average estate size or house price inflation would be better but are Government likely to do this? Probably not!
A radical overhaul of the IHT system is probably needed to make it fair bu that t is probably not going to happen. A fairer system would see only the rise in values on death being taxed akin to a capital gains type regime, with a charge on death on assets that have increased in value since acquired – the double taxation argument then goes away, but the drop in revenues would be too much for a Government to risk the political outcry – so also an unlikely outcome from any “simplification” review.
Ways to reduce your inheritance tax liability
Individuals are better to take their own affairs in hand and not rely on Government to reduce your inheritance tax liability on death.
There are a number of IHT exemptions and reliefs and we have touched on these in previous articles. The most useful are outlined below
- An often overlooked exemption being “normal expenditure out of income”. This allows regular gifts to be made out of income and, provided the gifts do not reduce the donor’s usual standard of living, there is no limit to the amount that can be given away and the amounts are immediately exempt from IHT. There is no need to wait the seven years and the amount that can be given away each year can increase as excess income increases.
- Cash gifts out of capital – these are Potentially Exempt Transfers (PETs) and will fall outside of the estate after 7 years from the date of the gift. If large gifts are made you should consider effecting a 7-year term assurance life policy to cover the amount of tax on the value of the gift, so the tax can be paid if the PET comes back into charge.
- Lifetime gifts into Trust. The NRB is available during lifetime, not just on death. With forward planning, it can be effectively recycled by gifting capital every seven years. This strategy can remove a considerable part of wealth from the estate over time. Gifts into trust also provide other advantages in terms of protection of assets and allowing any gain on the asset being gifted to be held over, so it can be a good way of transferring assets that are pregnant with gain, as we say!
The financial services market has also developed a range of products to assist with IHT planning to help you reduce your inheritance tax liability, including:-
- Qualifying Business Property Relief investments to shelter any value from IHT after 2 years of ownership
- Discounted Gift trusts – which can give an IHT reduction whilst retaining a return from the gift in the form of tax free capital repayments
- Gift and Loan trusts, to put future asset growth outside of the estate.
What is your estate worth?
As a first step to any planning, clients find it a worthwhile exercise to prepare a Personal Balance Sheet and then keep this up to date – not only is it a good housekeeping exercise, but also assesses the size of the estate and any potential IHT liability that could hit the estate in the future. This can then help as a foundation to future planning.
Use the ready reckoner here to assess the value of your assets. It may just start you thinking and you may then want to consider early planning to reduce any potential IHT burden in the future – it is a tax that is unlikely to be going away as it continues to bring ever increasing revenues into the exchequer!
And remember if you need any assistance or advice on how to reduce your inheritance tax liability, give me a call on 0203 146 1606.
Article by Paul Dell
Partner and Probate Adviser