High time to consider IHT?

As a result of frozen inheritance tax (IHT) allowances, and rising estate values, more people need to consider what IHT is, how it affects their estate, and how those left behind finance the costs, especially if there is insufficient liquidity in the estate.

Lifetime inheritance tax planning

IHT receipts climbed to £4.1bn between April 2021 to November 2021, £600m higher than the same period a year earlier. This suggests individuals are not seeking appropriate legal advice on ways to manage their tax bill.

IHT is a tax on the assets of someone who has died, including their property, money and possessions. Many people have drifted into the IHT net following an increase in property values, particularly in the South East. IHT is not often at the forefront of people’s minds. However, there are a number of ways you can cut your estate’s tax bill and increase the amount passing to your heirs. To avoid any pitfalls, it’s important to know the rules.

The basics - IHT relief

Key terms include: 

• Nil rate band (NRB): the first £325,000 of your estate will be tax-free.
• Residence nil rate band (RNRB): your estate may qualify for this relief where you leave some of your family home to direct descendants; this allowance is currently £175,000 and tapers off if the net estate exceeds £2m.
• Spouse exemption: all assets which pass to your spouse or civil partner are free of IHT. Any unused NRB and RNRB can be used by your spouse or civil partner.

Take Bob and Sarah, a married couple with total assets of £1.5m. Bob dies, leaving all his assets to Sarah; there is no IHT to pay due to spouse exemption. On Sarah’s death, her executors can use her own NRB plus Bob’s NRB, totalling £650,000. Both RNRBs are also available at £350,000, as the family home passes to their children. Together, £1 million therefore passes free of IHT. This means that only £500,000 is subject to IHT at 40 per cent, so the bill comes to £200,000, assuming there are no other reliefs available.

Aside from the basics, what other strategies can you consider during your lifetime?

Gifting

As the saying goes, it’s better to give than receive. One of the simplest things you can do to reduce IHT is to give money away during your lifetime. Outright gifts are potentially exempt from IHT and there is no limit on the amount you can give, but the 7-year clock begins ticking once you have made the gift.

Although taper relief reduces IHT on gifts where you survived between three to seven years, this is only relevant where gifts total more than £325,000. Therefore. it is sensible wherever possible to make use of the automatic exemptions:

• Annual exemption: each person may gift £3,000 each tax year without IHT. You can rollover the previous year’s unused exemption, allowing tax-free gifts of £6,000.
• Wedding gifts: parents and step-parents can give up to £5,000, grandparents can give up to £2,500 and others can give up to £1,000.
• Small gifts: you can make as many gifts of up to £250 as you wish, but the recipient cannot receive more than £250 per tax year.
• Gifts out of excess income: if a gift is regular, can be shown to have come from your income and does not affect your standard of living, any amount can be given away free of IHT. You should keep careful records of your income and expenditure.

Gifts could be for a variety of things, such as grandchildren’s education, or put towards a child’s first home. It will make your executors’ lives much easier if you keep records of any gifts made. Ensure  any gifts you make with a view to saving IHT do not trigger other taxes, especially Capital Gains Tax (CGT).

The biggest asset most people have is their home, yet gifting this to your children won't work if you continue to live in it rent-free, and the gift could affect the availability of the RNRB. It is possible to pay rent to prevent a gift with a reservation of benefit. However, this needs careful advice, and the rent must be full market rent and regularly reviewed. 

Leaving money to charity

You may be keen for a portion of your wealth to be used for charitable causes. Gifts of any size to UK registered charities are free of IHT and may also qualify for Gift Aid when given during your lifetime.

A gift to charity in your will is not subject to IHT. What’s more, to encourage charitable giving on death, a gift of 10 per cent or more of your net estate to charity reduces the rate of IHT on the rest of your estate from 40 per cent to 36per cent.

Business relief  

Some investments qualify for business relief, and these will be exempt from IHT if they have been held for more than two years. This includes many shares listed on the Alternative Investment Market (AIM), providing a valuable way to leave businesses to the next generation.

Pensions and life insurance

Thanks to auto-enrolment, more people are saving into a pension than ever before. Pensions are one of the most tax-efficient ways to pass on your wealth, because your pension falls outside of your estate for IHT and unused savings can be passed to your heirs.

The money in your pension isn't covered by your will, so you should update your nomination to inform your pension provider of your beneficiaries. Flexible pensions usually let you pass on your pension to your beneficiaries tax-free if you die before you reach 75. After 75, your beneficiaries may pay income tax on anything they take out of the pension.

Life insurance schemes also fall outside of your estate and are not subject to IHT if life cover is written in trust. This also allows policy proceeds to be claimed without delay.

Trusts

Assets transferred into trust are no longer subject to IHT on your death. You can retain control of your assets by putting them into a trust of which you are a trustee, provided they are used for the benefit of someone else. For example, you may wish to reduce your estate by providing for your grandchildren without placing the assets under their control. A trust can ensure they cannot access the assets whilst they are young and you can control any spending.

Gifts to trust should be limited to £325,000 to avoid an immediate tax charge. You will need to survive the gift by 7 years.

Practical steps

In addition to saving tax by effective lifetime planning, you can benefit your heirs by putting your affairs in order so as to save time and expense after your death. Having a valid will in place allows you to choose how your assets will be distributed and ensure your executors minimise the IHT bill using the available reliefs at the right time. Making a list of all your assets and letting your family and executors know where it is will assist greatly, and avoid wasting time tracing assets after your death. If you hold a joint account with the person who will benefit on your death, they will have early access to those funds after your death. This can be particularly useful because the process of releasing funds to beneficiaries can take considerable time.

Paying for IHT

The harsh reality is, irrespective of prudent in-life legacy planning, for some, paying a significant level of IHT is unavoidable. According to most recent HMRC statistics, more than 22,000 estates were subject to IHT in 2018-2019, paying an average tax bill of £209,000. It is widely expected that the next data release in July 2022, will show a sharp increase in estates being caught by IHT, a trend which is forecasted to continue until 2026, while allowances remain frozen by the government, and the economy continues to thrive.

The challenge facing executors and beneficiaries is, when the time comes following a bereavement, they are often not prepared for, or expecting, the financial burden that they will face. A large proportion of estates will not have made sufficient provisions to cover the costs of the funeral, the celebration of life, professional fees, or IHT. With the majority of estate wealth being held in property, there is also a considerable cost of maintenance, insurance and preparation for sale. Some of these costs can be deferred by the firm and third party services providers. However, this, in turn places a considerable cash-flow burden on their own respective finances. As a result, firms are also more frequently developing alternative commercial models which require certain fees to be paid frequently during the probate process.

While it is the executor that is accountable for discharging estate liabilities and costs, it is the responsibility of all beneficiaries collectively to agree how this is done, in the interests of all parties. They must decide on the following financing options:

Working with financial institutions to access the estate

Where cash resources are available, or there are accessible assets which can be liquidated during probate, banks and insurance companies may allow these to be used. However, a strict process will need to be followed, often subject to delays as a result. Even once accessed, it is likely the resources made available will be insufficient to cover all liabilities and costs.

Working with HMRC to reduce the initial bill

Similarly, HMRC processes can be inefficient and impacted by delays. Once the IHT liability has been calculated, the due amount will need to be paid within 6 months of the bereavement. Where an estate is experiencing financial stress, an application can be made to pay by 10 equal yearly instalments. However, with the average IHT bill being £209,000, this means the initial payment will still be an average of £20k. There are charges and fees associated with this scheme, and it will need to be managed over a 10 year period, or until it can be discharged in full by the estate.

Borrowing from friends and family

The most cost-effective option is for the executor to work with beneficiaries to unlock their financial wealth that can be accessed temporarily until a grant is issued and estate is unlocked and liquidated. This approach relies on the availability of accessible cash, and willingness of beneficiaries to co-operate. For those wealthy enough to have the required resources to discharge liabilities, it is possible such resources may be locked in investments and other assets. This means consideration will be needed as to compromises on yield, value or redemption costs.

Personal finance

It is possible for an executor or beneficiary to obtain a personal loan or a standard bridging loan; however, this is typically provided on a secured basis and subject to status. Individuals may be reluctant to share sufficient information required for a credit check, have non-standard income or be nervous about taking personal risk to benefit the administration of an estate. Personal finance will also require regular monthly servicing until the loan is repaid.

Specialist probate finance

An emerging and innovative option is to apply for a specialist probate bridging loan. These products are relatively new to the market, but have been developed to require no personal risk, or monthly repayments. This is because such loans are secured wholly on the estate itself, and effectively advances the value of an estate ahead of a grant or asset sale. Ultimately whatever solution is suitable for a client's specific circumstances, they should always seek advice from their professional adviser.

Simon Dawson is chief commercial officer with Legacy Release, and Jessica Jamieson, is partner with Cripps Pemberton Greenish legacyrelease.co.uk and crippspg.co.uk