Chapters Financial News

Inheritance tax can be a thorny issue and a difficult topic to consider between partners and relatives. It's quite natural to want to avoid the subject of death, particularly your own or of loved ones, and this reticence can mean that opportunities for important tax planning during life are missed.

Data published by HMRC in July 2023 showed that inheritance tax (IHT) receipts for June 2023 were £795 million – the highest monthly total on record. IHT receipts for April to June 2023 inclusive were approximately £2bn, which is £200M higher than the same period in 2022. The Office for Budget Responsibility (OBR) predicts that IHT will raise £7.2bn in the tax year 2023/2024.

As comparators, IHT receipts totalled £7bn in 2022/2023 and £6.1bn in 2021/2022. IHT receipts have increased as a share of GDP since the tax year 2009/2010, in significant part owing to the rise of asset values. The OBR notes that residential property makes up the largest share of most estates, and that average house prices have risen by over 70% between 2009 and 2022. In addition, the freeze of the nil rate band at £325,000 per person from April 2009 until the tax year 2025/2026 at the earliest has created fiscal drag. Remember, we are likely to have a general election in the autumn of 2024, if not before, so this position might change.

The total number of liable estates has also increased every year since 2009/2010, with 27,000 estates being liable to IHT in 2020/2021 (source: Inheritance Tax Statistics: inheritance tax statistics ).

It is interesting to note that IHT receipts are rising despite an increase in the number of claims for the Residence Nil Rate Band (RNRB) – an addition to the standard nil-rate band which is applicable when a residence is passed on death to a direct descendant.

The RNRB is just one of the ways in which exposure to IHT can be managed and we've looked at this and other possible IHT planning strategies below.

Make a Will

One of the cornerstones of financial planning (and IHT planning) is to have a valid and up to date Will in place. As noted above, each individual has a standard nil rate IHT band of £325,000. Spouses can pass this to the surviving spouse/civil partner on death, affording a joint estate protection normally to £650,000. Thereafter, inheritance tax is usually charged at 40% on any balance above this level.

If you're not married or in a civil partnership, you cannot pass on your nil rate band to the surviving partner, making a valid Will all the more important.

Many have adjusted their Wills some years back (before a rule change to allow the passing of the nil rate band to a spouse), by moving property ownership from 'joint tenants' to 'tenants in common'. This now may have limited value for inheritance tax purposes but can still have some advantages for long term care planning.

Powers of Attorney / Health & Wealth

If you are updating your Will, take some advice at the same time on establishing Power of Attorney arrangements. There are two types – health and wealth – and it may be sensible to put these in place.

Think about leaving a charitable legacy

Gifts to charities are not subject to IHT and if you make significant gifts to charities from your estate, the inheritance tax charge can fall. Your estate may qualify to pay inheritance tax at a reduced rate of 36% (rather than 40%) if you leave at least 10% of your net estate to charity. HMRC has developed a helpful calculator which is useful in working out the amount needed to qualify: inheritance tax reduced rate calculator

Consider gifting in lifetime

There are a range of ways in which gifts can be made to reduce an estate's liability to IHT. Indeed, the 'Bank of Mum & Dad' has been busy in this regard in the last few years.

Gifting needs to be planned carefully to ensure that conflicts do not arise between the desire to reduce tax after death and the need for funds during life (e.g. for long-term care needs). Chapters Financial can of course provide advice on this issue. Here are some points to consider:

• Annual Gift Allowance: £3,000 per donor pa. If you did not use last year's allowance, you can go back one year to gift £6,000. Therefore, a couple could as an example give away £12,000. We think it is sensible to document this gifting in letter format to provide a suitable audit trail.
• Gifts from surplus income: if after applicable tax, you have surplus income over and above what is needed to maintain your standard of living, this can be given away and should usually fall outside the estate immediately. This income can be gifted either directly to the recipient or into a trust and you might wish to establish a family trust to achieve this. The calculation to ensure that any surplus remains such should be documented each year because it will be needed for probate purposes. Care and planning is required here because some 'income', such as 5.0% gross pa withdrawals from investment bonds, are treated as return of capital and are not income for this purpose.
• Potentially Exempt Transfers (PETs): If you want to make lump sum gifts away from your estate, either to a recipient or to a trust, you can do this (although the gift only falls fully outside your estate after seven years). There are beneficial tapering factors applicable from HMRC and these can be found here: inheritance tax/gifts.
  Any gift (PET) made above the nil rate band of £325,000 can still be made, but it should be noted that any inheritance tax charge that may become due would fall on the recipient, rather than the estate.
• Establishing Trusts: For some, the thought of giving away funds directly to relatives does not appeal. This may be because the beneficiary is too young, even unborn (e.g. future grandchildren), or that they may not use the money as you would intend. This might be a good reason to use a Trust, and your legal advisers can help establish an appropriate arrangement. Suitable gifts can be made to a Trust, usually with the Trustees deciding how future funds are distributed across a group of beneficiaries (named or as a class, such as grandchildren). This can offer a solution to gifting now, whilst maintaining control over the funds in the future. It's important to obtain suitable legal and accountancy advice when setting up a Trust, noting that significant tax implications can apply, and that most Trusts now have to be registered with HMRC.

Don't ignore the Residence Nil Rate Band

This additional allowance was introduced in the tax year 2017/2018 and applies when a residence is passed on death to a direct descendant (i.e. children and their lineal descendants). It only applies to one residential property, and it must have been a residence of the deceased (so a buy-to-let property wouldn't qualify). The maximum amount of this was phased in over time, as follows:

• 2018/2019: £125,000
• 2019/2020: £150,000
• 2020/2021 onwards: £175,000 (frozen until 2025/2026 at the earliest)

Married couples can pass the additional allowance to a surviving spouse or civil partner. Couples who are not married or in a civil partnership cannot, in line with the rules for the standard nil rate band.

The rules regarding the residence nil rate band are complex and caveats and exclusions apply.

Nominate your pension funds

You may well have built up a range of pension plans over the years and it's important to keep the nomination of death benefits up to date on all of these, in line with your life changes.

For money purchase pension plans, the value of your pension plan usually remains outside your estate for IHT purposes and accessible to your beneficiaries without recourse to probate, which can be a helpful source of funds at a difficult time. The fund value can pass tax-free to your chosen beneficiary/beneficiaries on your death before your age of 75. After this time, the fund can pass to your beneficiaries and will be taxed at their marginal rate of income tax.

It is important to note that if a death occurs within two years of a change in nomination, HMRC may want to check that this change was not achieved with the aim of reducing any tax position. As an additional point, and in the same way, HMRC may also investigate a pension transfer that took place within two years of death.

If you're fortunate enough to have final salary (defined benefit) pension benefits, either in payment or in deferral, these could provide a spouse's pension on your death, and possibly even a pension for your children in some cases. If you're not married or in a civil partnership, it is important to check the scheme rules to see whether the scheme would pay a dependant's pension to your partner, as some schemes may not allow this.

Review, review, review

Solutions to inheritance planning are numerous and invariably use annual allowances. Using a combination of the options noted above is not uncommon, perhaps including a series of gifts. It is important that any planning is reviewed regularly to ensure that it still meets its objectives, that annual gift allowances are used, and that if you are making substantial gifts during your lifetime, your needs are still protected.

Summary

As you can see, there is much to consider in terms of managing exposure to inheritance tax. The team at Chapters Financial is qualified to help clients and enquirers in this area and we are happy to work with your legal advisers to meet your ongoing needs. There is no individual advice provided in the content of this blog.

Vicky Fulcher
Director
CFP^TM Chartered MCSI

Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899.