IHT – Less to the taxman, more to your family.

Article by Phil Mason

Lord Jenkins stated over 30 years ago “Inheritance tax is, broadly speaking, a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”.

According to U.S data provider Cerulli Associates, over the next 25 years, $68 trillion of wealth will be transferred to family members in the U.S. alone. Closer to home, HMRC reported that £5.2bn of tax was paid on estates in the 2017/18 tax year, compared to £2.4bn that was collected in the 2009/10 tax year. The forecast for this tax year is £5.7bn in tax will be paid on estates. The chart below shows historic (yellow) and predicted (blue) tax claimed via IHT:

“The first person to live to 150 years has already been born” is a quote I have heard many times before and taken as being fact, but only recently did I bother to do some actual research in to whether this is true or not. I concluded my research that there is no hard and fast scientific or medical facts to back up this claim, and is just a prediction/intuition of a few people from within the science and medicine profession, one source has even gone as far as to claim “the first person to live to 1,000 years has already been born”.

Whilst both of those claims may be a bit ambitious, one thing is for certain, more people are living longer than ever before. The ONS reports that children born in 2019 will have an average life expectancy of 90, and will have a 1 in 4 chance of living to age 100. Compare that to a 65 year old today, where their life expectancy is 86, and has a 1 in 20 chance of reaching 100.

When it comes to the issue of estate values and inheritance tax (IHT), the benefit of living longer is it gives people more time to arrange and address any issues with their estate, the downside is it gives more time for estate values to grow, further compounding the problem of IHT. This is one of the 3 main issues relating to IHT, with the other two being rising house prices and no increase in the Nil Rate Band.

To help combat the rising house price issue, the Government introduced the Residence Nil Rate Band (RNRB) in April 2017, this is in addition to an individual’s own Nil Rate Band (NRB) which is £325,000 as of 2019/20, and conditional on the main residence being passed down to direct descendants (e.g. children, grandchildren).

In order to see how the NRB and RNIB impact on an estate and the taxation, let’s look at an example case study.

Mr Smith is a 72 year old widow. He is retired and in relatively good health. He has two children that are grown and have families of their own, both of his children are not financially dependent on him. Mr Smith’s estate is made up of:

Main Residence £650,000
Current Account £50,000
Premium Bonds £50,000
Cash ISA £50,000
Stocks & Shares ISA £200,000
Investment Portfolio £400,000
Total £1.4m

Mr Smith has no mortgage and no debts, he has sufficient income from his State Pension and private pension to cover all expenditure.

Mr Smith inherited 100% of his deceased wife’s Nil Rate Band, which gives him a total of £650,000 including his own Nil Rate Band.  Let’s now look at Mr Smith’s position regarding his estate versus his Nil Rate Band.

Total Estate Value £1.4m
Nil Rate Band (NRB) £650,000
Excess over NRB £750,000

The excess amount over the NRB is liable to Inheritance Tax (IHT) at 40%. This means Mr Smith’s children would face an IHT liability of £300,000 in the event of Mr Smith’s death. (£750,000 x 40% = £300,000).

However, if Mr Smith leaves his main residence to his children, the RNIB allowance is then factored in to the estate value. The RNIB allowance amount will be phased in and is shown in the table below, combined with the NRB to give a total estate value threshold:

Mr Smith also benefits from the RNRB allowance from his widow, meaning he gets the full NRB and RNRB allowances of £950,000 for 2019/20 and £1m for 2020/21.

In this Scenario, Mr Smith passes away in 2021, leaving the estate value of £1.4m to his two children. The IHT position would now be as follows:

Total Estate Value £1.4m
NRB Allowance £650,000
RNRB Allowance £350,000
Total Allowance £1m
Excess over NRB + RNRB £400,000
Tax Liability at 40% £160,000

Whilst this has greatly reduced the amount of IHT liability, there is still a substantial tax liability on Mr Smith’s estate. With the help of a financial adviser, Mr Smith could take appropriate action in order to eradicate or minimise the potential IHT liability on his death.

Suitable solutions will depend on an individual’s circumstances, objectives, and requirements, but some of the options available to either reduce the estate value or provide a solution to the IHT liability could be: 

•A life insurance policy written under Trust:

Mr Smith and/or his two children would pay a monthly premium in exchange for life cover on Mr Smith, that would pay out £160,000 to his children in the event of his death. His two children would use this to pay the outstanding IHT liability.

Some things to consider here is that the monthly premiums are likely to be very expensive and the £160,000 pay-out amount is fixed at outset. If the value of the estate were to grow in future, either through investment growth or increases in property values, there could still be an IHT liability to pay in excess of the £160,000.

•An investment written in to Trust for the benefit of the two children: 

Mr Smith could use a tax wrapper, such as an investment bond, written in to trust for the benefit of his two children in the event of his death. This would remove some of value of the investment from Mr Smith’s estate immediately with the rest being treated as a Potentially Exempt Transfer (PET) which is included for up to 7 years. The amount of tax applicable to a PET reduces on a sliding scale from 40% if death occurs within the first year, down to 0 if death occurs after 7 years.

The main thing to consider here is that Mr Smith would have to give up any and all access to the funds written in to trust.

•An investment into a product that qualifies for tax relief, such as Business Property Relief (BPR). 

This type of investment allows the investor to retain control and access to their funds if required. If the investment is held for at least 2 years, then the full amount will be outside of the estate. The main thing to consider here is that these types of investments are generally considered as being higher risk so need careful consideration when being included in a portfolio.

•An outright gift to his children that will qualify as Potentially Exempt Transfers or Chargeable Lifetime Transfers.

Each individual has an annual gift allowance of £3,000 which does not fall under the value of your estate for IHT purposes and is not subject to the 7 year rule. In this scenario, Mr Smith would need to gift upwards of £400,000 in order to bring his estate value below the £1m value if he wanted to totally avoid IHT, which means any amount above £3,000 would remain in his estate for up to 7 years.

As long as Mr Smith survives 7 years from the date of the gift, there will be no IHT payable on the gift amount.

If you would like to discuss your circumstances and are considering any potential IHT issues, please contact our financial advisers who will be happy to explore this with you and advise accordingly.