What if... you could protect your legacy from the taxman

In 1789, Benjamin Franklin wrote “...nothing can be said to be certain, except death and taxes”.

In the case of Inheritance Tax (IHT) both of these certainties coincide. 

IHT, in one form or another, has been around in the UK ever since the Stamps Act 1694, and has, at least in my working life, always been an emotive subject and the desire of successive Governments to tax people on death has been countered by equally enthusiastic innovations to avoid it.

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After Labour’s recent budget, the subject of IHT has been thrust right back on to centre stage with a double whammy. The exemptions for agricultural property and pensions will be either reduced or removed over the next few years (agricultural property changes from 6 April 2026 and pension changes from 6 April 2027). There is now probably more demand for advice on IHT than at any time I can remember.

IHT planning is not a new thing, although it is true to say that there is probably less room for manoeuvre than there used to be. Over the past thirty years or so, many previously effective methods have been stamped out by HMRC and, in some cases, it has been costly to unwind complex arrangements which have been rendered useless.

With the inherent dangers of contentious schemes, it may be worthwhile visiting, or even revisiting, some of the uncontentious methods which have passed the test of time.

There are still measures which can be taken to mitigate, if not eliminate, IHT but before doing anything, it’s important to know what the current situation is going to mean for you and your family, and the first step is to fully understand the current exemptions.

What are the current IHT exemptions?

Under current rules, individuals (providing they are UK domiciled) are entitled to pass down on death, the entirety of their assets to their spouse of civil partner, completely free of IHT. This is known as inter-spousal exemption. So, for many couples, this means that the liability occurs only on second death.

Everyone is entitled to pass on assets with an exemption (known as the Nil Rate Band or NRB) of £325,000. In addition, if you own a primary residence, there is an additional exemption of £175,000 known as the Residents Nil Rate Band or RNRB when passing down to direct decedents. Importantly, both the NRB and the RNRB, on death, can be inherited by the surviving spouse or civil partner (unless gifts were made seven years before death. As such, most couples, who have not gifted and have a house, will, on second death, have an NRB of £1m (although the RNRB is tapered down if the individual estate is in excess of £2m). It is the estate in excess of the NRB which will be taxed at 40% (or 20% for some other assets including agricultural property).

Gifting

Gifting is probably the oldest and most effective form of IHT provision. There are host of smaller exemptions) but for meaningful gifts the basic concept is that you can gift assets and, providing you do not retain any ‘enjoyment’ from them, they will be outside of the estate once seven years has lapsed from the date of the gift. If you die before the seven years has lapsed then it becomes a failed gift and some or all of the gifted assets will still be considered part of the estate for IHT purposes. Many people have heard about ‘taper relief’ whereby the liability to IHT reduces after the third year of a gift. The rules for taper relief are complex and, in reality, only apply to gifts in excess of the NRB of £325,000.

Retaining an enjoyment (such as gifting your house to your children but still living in it) will render the gift a ‘gift with reservation’ and it will fail the exemption test and still be aggregated with the rest of the estate on death.

It is worth noting that all gifts or legacies to charities are completely exempt.

The idea of gifting appeals to many but they do not like the idea of gifting large assets, outright, to young (or sometimes not so young) children. In these circumstances, trusts can play a big part.

Trusts

Although definitely more onerous to administer these days, trusts still represent an effective mechanism for gifting and retaining control (as a trustee) without gaining any ‘enjoyment’. Assets can be gifted into trusts and (subject to permissions of the trust) the trustees can decide who benefits and, crucially, when. 

Another consequence of the Chancellor Rachel Reeve’s IHT hit on pension schemes in the Autumn Budget is that some Death In Service (DIS) arrangements will be caught in the tax net. DIS is normally an employer sponsored benefit which pays a lump sum on the death of an employee. If the scheme is written under trust, the proceeds bypass the deceased’s estate and will not be affected. However, if there is no trust in place, the proceeds effectively form part of the pension fund which will, after 2027 be subject to IHT (subject to consultation). Anyone in doubt about their own scheme should seek advice.

There are many different types of trust so financial and legal advice is always recommended.

Life Insurance

Many years ago, ‘whole of life’ insurance policies were a popular and uncontentious way of dealing with IHT. Since the budget, there will be many who simply cannot gift assets as the assets themselves are needed to generate income. For those, insurance could be a simple and effective solution and at TPO we anticipate a resurgence in the popularity of this tried and tested route.

Life insurance does not remove IHT, but it provides the beneficiaries of the estate with a tax-free lump sum at precisely the time when HMRC will be knocking on the door of the executors asking for a large IHT bill! In essence, a life insurance policy is effected which is designed to pay a lump sum on death, or second death. The policy is written into a simple trust which then pays the proceeds directly to the beneficiaries of the estate (normally the children of the deceased parents) and as it is in trust it does not fall into the estate for IHT purposes. This is crucial because if there is no trust, the proceeds will fall into the estate of the deceased, and this will merely exacerbate the problem. The cost of the policy can be cheaper than you think. 

The cost of the policy can be cheaper than you think. For instance, at the time of writing, a husband and wife, aged 55, both non-smokers, can secure a sum assured of £500,000, payable on second death for £442.02 per month (subject to satisfactory underwriting). This may sound a lot but providing premiums are maintained the policy definitely will pay out on second death, and it would take over ninety-four years before the premiums added up to more than the sum assured. * 

One area of planning which always raises an eyebrow is for unmarried couples to get married (thus securing interspousal exemption). Hardly a romantic reason to get married, I know, but from an IHT point of view, stone cold good sense!

This is by no means an exhaustive exploration of IHT mitigation and, as always, advice from a Chartered Financial Planner and/or solicitor should be sought.

If you’d like to learn more about how to minimise the tax on your estate, why not get in touch for a free initial consultation.

* Source L&G - The Exchange 

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

The Financial Conduct Authority (FCA) does not estate planning, tax or trust advice.

The information contained in this article is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change.